Appendix 1:The Neoclassical Model ofEconomic Growth

The model was introduced by Solow (1956). It starts with a standard neoclassi­cal production function augmented by exogenous technology that increases theproductivity of the factors.' Aggregate output Yat time t is a positive functionof the aggregate inputs labour L and capital K and the level of technology A.We assume that this function has the following Cobb-Douglas-form:

Y, =A~: 11: AU

This production function is assumed to exhibit constant returns to scale: dou­bling both inputs leads to a doubling of output. A crucial feature of the Solowmodel is the standard neoclassical assumption of decreasing returns to capital ,that is. b < I . Each additional unit of capital added to a constant stock ofworkers diminishes the marginal return of the next unit. This assumption meansthat at the limit the marginal return of capital reduces to zero. The first machineinstalled in a firm with a fixed stock of workers has the highest marginal return.Every additional machine contributes fewer marginal returns until crowdingeffects lead to the point where a further machine of the same type contributeszero additional returns.

The other crucial ingredient of the Solow model is a simple Keynesianinvestment function. Gross investment equals savings and a constant fraction sof output is saved in every period.! To analyse the potential output of theeconomy we are interested in how this investment affects the capital stock; thatis. we are interested in net investment. If we therefore assume that in everyperiod a constant fraction c of the capital stock wears out, the effective changein the capital stock dK is:

dk, = sAK~ L~' - cK, A1.2

Population and therefore the labour force is assumed to grow at constant rate n.With the assumption of constant returns to scale it is convenient to simplify thefunction to per capita terms, defining k,as capital per worker, KIL, in time t.3 Bytaking derivatives of k,with respect to time, (Equation A1.2) can be rewritten as:

dK, =sA~ - (c +n)k, A1.3

As can be seen, the difference between per capita and absolute terms is theterm Ilk,added to ck,. This can easily been understood if one interprets popula­tion growth as a form of depreciation. If during a given period the workforce

169

170 Appendix J

grows at the rate n, the existing stock of capital has to be spread more thinlyamong a larger population . This signifies that capital per worker reduces by nover the period .

To simplify the following discussion we can divide both sides of (EquationA1.3) by k.:

dk,/ k, = sAk,b-l - (c + n) AlA .

Equation A104 is the crucial equation of the Solow model. It simply states thatthe growth rate is detennined by the difference between gross capital accumu­lation (sAk~ -I) and capital depreciation (c + n). The dynamics implied by thiscondition can be shown with the help of a very simple graphical device (FigureA1.1) .4

The graph represents the two right-hand expressions of Equation (A 104) asfunctions of capital per worker, k. The function c + n is not dependent on k andis therefore represented as a horizontal line. Because of the assumption ofdiminishing returns to capital (b < I) the function sAki'-1 is downward sloping.The intersection of these curves represents the equilibrium level of capital perworker, k·. This can easily be shown if we consider a capital stock kO < k·.Then accumulation sAki' - I exceeds depreciation c + n. In this case, accordingto Equation AlA, dklk is positive and consequently the capital stock is growing

sAk b-l

c+n

c + n 1----)~H~~-IJ)l.".....----------

k"

Figure A1.1 Illustration of Solow model

sAk b-

1

k,

The Neoclassical SolowModel 171

over time. This process continues until kO is reached. The same argumentapplies if we start with a k > kO. The equilibrium capital per worker ratio kO, iscalled a steady state. For given parameters A, s, nand c, an economy alwaysreaches the same level of output, determined by kO. This formulation of theSolow model has the problem that if an economy has reached the steady statelevel, k, the growth rate falls to zero. Traditional neoclassical growth modelsmeet this difficulty with the heroic assumption that technological progress Agrows at rate g.5 In the graphical representation this means that in the steadystate the function sAJ(, -1 is shifting outward at rate g.6

To summarise: if as a consequence of an exogenous shock an economyleaves the steady state, these parameters (the level of technology A, the savingsrate s, the rate of population growth n and the depreciation rate c) produce adynamic process of convergence to the steady state kO. If these underlying para­meters are the same, economies will converge to the same steady state. In otherwords, according to the Solow model of economic growth, in the long-termone should expect all economies to reach the same level of output and the samegrowth rates, given that they do not differ in the basic parameters.

Appendix 2:Private Sector Questionnaire

Department of Economics

PRIVATE SECTOR QUESTIONNAIRE

FOR CONFIDENTIAL USE ONLY

This is a questionnaire for a world-wide comparative study on theinstitutional obstacles to private sector investment. We guaranteethat all questionnaires will be handled strictly confidentially.

Intermediate Organization _

Country _

Date of interview _

Name of company _

Address of company _

Field of activity _

Number of employees _

Special remarks _

172

Private Sector Questionnaire

GOVERNMENTAGENC~

173

I. Please evaluate the following quotation for your country : 'Laws andregulations are so complicated, unclear and sometimes even contra­dictory that it is impossible to adhere to them on a regular basis.Therefore, civil servants can always find ways and means to giveyou a hard time (long delays, arbitrary decisions),'

This happens:- never [ ]- rarely [ ]- sometimes [ ]- frequently [ J- mostly [ J- always [ J

2. Assume that you are confronted with clearly unfair procedures oroutright demands for bribes by a civil servant. Would you try toresist and fight back either by appealing to his superior, or to anadministrative court?

You would (v. .) fight back.- never

rarelysometimesfrequentlymostlyalways

[ J[ ][ 1[ ][ ][ ]

3. Please evaluate the following quotation for your country : 'As anentrepreneur you are always afraid of committing a small 'error'here and there in the eyes of the regulatory bodies because these'errors' can be (ab)used by civil servants to gain a position of power(and construct a case to blackmail you),'

This is ( oo .) the case.- never [ ]- rarely [ ]- sometimes [ J- frequently [ J- mostly [ J- always [ J

174 Appendix 2

4. If you know the civil servant you have to deal with personally , canthis speed up the procedure?

Knowing the civil servant personally will (. ..) speed up theprocedure.- never [ ]- rarely [ ]- sometimes [ ]- frequently [ ]- mostly [ ]- always [ ]

5. If you know the civil servant you have to deal with personally, canthis influence his decision (e.g. amount of taxes, issuing a businesslicense)?

This will (... ) influence the decisions of civil servants.- never

rarelysometimesfrequentlymostlyalways

[ ][ ][ ][ ][ ][ ]

6. Do you think that during the last 10 years uncertainties in dealingwith government agencies have C••• )?

- increased [ ]- remained about the same [ ]- decreased [ ]

LAWMAKING

7. As an entrepreneur, do you regularly have to cope with unexpectedchanges in laws and/or policies which could seriously affect yourbusiness?

Changes in the laws and policies are:- completely predictable [ ]

highly predictable [ ]fairly predictable [ ]frequently unpredictable [ ]mostly unpredictable [ ]completely unpredictable [ ]

Private Sector Questionnaire 175

8. As an entrepreneur, are you officially or unofficially informed(through press, business association etc.) about new laws and/orplans to change existing laws or policies?

You are (. .. ) informed.- never

rarelysometimesfrequentlymostlyalways

[ ][ ][ ][ ][ ][ ]

9. In case of important legal changes affecting your business canyou voice your concerns indirectly and/or are you directlyconsulted?

You are (.. . ) consulted.- never [ ]- rarely [ ]- sometimes [ ]- frequently [ ]- mostly [ ]- always [ ]

10. Do you expect the government to stick to announced majorpolicies (e.g. a new tax law, an infrastructure project, a budgetgoal)?

- The government's announcement is (.. .) credible .- never [ ]- rarely [ ]- sometimes [ ]- frequently [ ]- mostly [ ]- ~wa~ [ ]

II . Do you think that during the last 10 years uncertainties in lawmaking have (.. .)?

- increased [ ]- remained about the same [ ]- decreased [ ]

176 Appendix 2

LAW ENFORCEMENT

12. Imagine a private conflict is brought into court with the evidencebeing very clearly in your favor. Do you have confidence that theassigned judge will enforce the law objectively?

Courts can (. .. ) be trusted to enforce the law objectively accordingto transparent rules.- never [ ]- rarely [ ]- sometimes [ ]- frequently [ ]- mostly [ ]- always [ ]

13. Please consider the following quotation for your country :'The party who pays more (e.g. bribes or better lawyers) will winthe case . Even if the evidence is clear money can change theresult.'

This is (. .. ) the case.- never [ ]- rarely [ ]- sometimes [ ]- frequently [ ]- mostly [ ]- always [ ]

14. Is it irrelevant which individual judge decides on a case? Is itadvantageous to know the assigned judge?

If you know the assigned judge personally this will (.. .) influencethe procedure and result.- never [ ]- rarely [ ]- sometimes [ ]- frequently [ ]- mostly [ ]- always [ ]

Private Sector Questionnaire 177

15. If you were treated unfairly in court (i.e. because of briberydemands or a decision you do not deem 'correct') would you fightthis by going to a higher court?

You would (... ) appeal.- never [ ]- rarely [ ]- sometimes [ ]- frequently [ ]- mostly [ 1- ~wa~ [ 1

16. Do you think that during the last 10 years uncertainties in lawenforcement have (... )?

- increased [ ]- remained about the same [ ]- decreased [ ]

Any comments on this questionnaire or on specific questions arehighly welcome

Appendix 3:Indicator of PoliticalCredibility

POLCRED8185 POLCRED8690 POLCRED8190

ArgentinaBoliviaBrazilCameroonChileColombiaCosta RicaEcuadorGhanaGuatemalaIndiaIndonesiaJordanMalaysiaMexicoMozambiqueNigeriaPanamaPeruRwandaSenegalSingaporeSri LankaSudanTanzaniaThailandTurkeyVenezuela

5.124.153.372.343.374.213.443.073.333.874.002.103.831.573.673.003.503.274.443.331.591.453.383.403.881.713.503.60

178

3.793.504.574.222.973.743.563.673.504.673.502.303.171.294.003.254.174.333.643.672.141.252.634.004.881.712.504.35

4.463.833.973.283.173.983.503.373.424.273.752.203.501.433.843.133.843.804.043.501.871.353.013.704.381.713.003.98

Appendix 4:~easurernentand

Indicators of Openness

SHORT-TERM EFFECTS OF THE EXIT THREAT

In the short tenn the exit of mobile factors can potentially reduce the govern ­ment's tax base. The threat to exit thus directly constrains discretionaryactivity. The effectiveness of an exit threat depends on the mobility of factorsand the size of the damage that would be imposed on the government bymoving mobile factors out of the country.

Capital Control

The monetary constitution of a country is a significant indicator of its openness.In order to classify the sample countries according to their degree of capitalrestrictiveness we focus on currency control regulations and exchange rate dis­tortions, (Table A4.1).

Currency Control Categories (CCC)

The World Currency Yearbook divides 146 countries into four categoriesaccording to the restrictiveness of their currency controls.'

Free currencies 'are units whose financial transfer to other countries is gen­erally not bound to licences or official permission. They are not the object ofblack market transactions' .

Units under liberal control 'are currencies whose free or black market valuediffers, often substantially, from Official Rates. But in countries of such liberalcontrol, ownership of fore ign bank notes, bank balances abroad or gold iseither legal or tolerated, and infract ions of currency legislation are not punish­able by jail'.

Units under strict control 'are, in general, the objects of active black markettransactions, have multiple official values, are surrounded by voluminous pro­tective legislation and cannot be transferred abroad without special permits orauthorization. Ownership of foreign monies or bank balances overseas isalways illegal and punishable by confiscation, heavy fines or prison sentences,deportation to camps and, sometimes, even by death for what is called 'crimesagainst the national currencies'.

179

180 Appendix 4

Table A4.1 Degree of capital control

SingaporeMalaysiaThailandIndonesiaChileBoliviaVenezuelaPeruGuatemalaArgentina

CCCI(1988)

FFSLLLLSLL

BMp2(1983-8)

(%)

0.001.000.003

7.2517.25

117.00140.6Q4129.00112.5032.25

Notes:I. F =free; L =liberal; S =strict. Our corresponding rating is A (free),

B (liberal) and C (strict).2. Black-market premiums are only available for the years 1983, 1984,

1986 and 1988; the listed premiums are the unweighted average of thesefour years. In 1988 there were black markets for foreign exchange inIII countries with a BMP range of I per cent to 6 600 per cent. Ranks1-37 with BMPs of 1-16 per cent were rated with an A in our survey,ranks 38-75 with BMPs of 17-87 per cent with a B, and ranks 76-111with a BMP greater than 88 per cent with a C.

3. Some monetary transfers need licensing.4. See Hausmann, 1990, p. 227.

Units under dictatorial control 'are currencies whose Official Rates areunrealistically high and are enforced by severe legislation. Statistics concerningcurrency in circulation are generally a 'State secret'. These units are, withoutexception, the objects of black market transactions, which often list foreignstrong currencies at extremely high premiums. Ownership of other thannational units is punishable by long prison sentences, deportation to labourcamps, and sometimes, even by death for what is called 'crimes against thenational currencies'.'

Currency control categories are available for all the countries in our sample,although not on annual basis because several issues of the World CurrencyYearbook were not at our disposal.

Black Market Premium (BMP)

The World Currency Yearbook lists the black-market premiums of 113 coun­tries. The premiums vis-a-vis the official or the effective rate are based on the

Measurement and Indicators of Openness 181

unofficial and/or illegal prices paid for the US, dollar in the trading centres ofthese countries.? 'The black market premium can be interpreted both as ameasure of expectations of depreciation of the currency (and therefore also ofcurrency overvaluation) and as a crude index of distortions . Expectations ofdepreciation may affect investment through several channels : first, it is moreattractive to hold foreign assets .. . second, economic uncertainty is higherunder such conditions.. .' 3

Stock and Annual Flow of Foreign Direct Investment (FDI)

Foreign direct investment is mobile capital and thus presents a formidable exitthreat, which is the more effective the larger the present stock and inflow ofFDI. We use the average stock and the annual flows ofFDI, both measured as apercentage of GOP over the period 1981-90, as rough estimates of the dam­age that could be done to a government by withdrawing or withholding FDI(Table A4.2).4

The Frost & Sullivan Index

A measure of the degree of openness to FOI is provided by the Frost &Sullivan index." While currency control categories and black-market premiumscan serve as proxies for the cost of capital outflows, this index mainly tries toevaluate the FOI attractiveness of a country. Regulation of labour markets orownership controls as well as other factors raise the costs of an investment andshould be regarded as restrictions to capital inflows.

The index constructed by Frost & Sullivan (FS) is based on fourteen differ­ent criter ia. For each country (the total number of countries covered is 95) ascore ranging from I (worst case) to 5 (best case) is given for each criterion .For the purpose of this study the five 'non-institutional' criteria have beenexcluded (domestic economic performance, international economic perfor­mance, labour conditions, security of operations, regime stability). Thisindex is thus the unweighted average of nine criteria: controls on ownership,approval process, dispute settlement, employment of nationals , performancerequirements, exchange controls, repatriation restrictions , investment incen­tives, and tax rates."

LONG-TERM EFFECTS OF THE EXIT THREAT:TRADE DISTORTIONS

Three indicators are used to evaluate this second category of openness; Leamer'sadjusted trade intensity ratio, the World Bank's index of outward orientation andthe real exchange rate distortion as compiled by Dollar (1992), (Table A4.3).

182 Appendix4

Table A4.2

Stock ofFDIas Annualflows ofFDI Frost & Sullivanpercentageof as percentage of index'

oo» (1981-90) ODp2(1981-90) (1988)

Singapore 55.7 (1) 9.40 (1) 4.7 (I)Malaysia 31.0 (2) 3.50 (2) 3.4 (13)Thailand 5.4 (10) 1.42 (3) 3.9 (6)Indonesia 8.8 (7) 0.47 (7) 2.9 (19)Chile 14.6 (3) 0.73 (6) 3.7 (9)Bolivia 6.0 (9) 0.26 (8) n.a,Venezuela 7.2 (8) 0.05 (10) 2.4 (24)Peru 9.3 (5) 0.10 (9) 2.3 (26)Guatemala" 11.4 (4) 1.24 (4) 2.8 (20)Argentina" 9.1 (6) 0.82 (5) 2.8 (20)

Notes:I. Stock of total FDI as percentage of GDP on average over the period

1981-90 calculated by adding FDllIows since 1979 (see IMF, 1993) tothe 1978 stocks (see UNCTC, 1983, p. 311 ff), The numbers in bracketsindicate ranks among the ten sample countries. Ranks 1-3 are rated withan A, ranks 4-7 with a B, and ranks 8-10 with a C.

2. GOP was converted from local currency into US dollars using annualaverage exchange rates listed in line rf of IMF 1993. The numbers inbrackets indicate ranks (see preceding footnote)

3. The scores range from I (most restrictive towards FDI) to 5 (most open) .The Frost & Sullivan (1988) sample quoted in Agarwala, Gubitz andNunnenkamp (1991, p. 36) consists of 29 developing countries.Numbers in brackets indicate the ranking of our sample countries in theF & S survey. Ranks from 1-9 correspond to an A rating, ranks 10-19to a B, and ranks 20-29 to C.

4. Data only available for the period 1981-89.5. Data only available for the period 1981-89.

Leamer's Adjusted Trade Intensity Ratio (ATIR)

Most indicators of openness look at directly recorded data on trade impedi­ments and distortions, In sharp contrast, the approach taken by Leamer (1988)is hypothetical in nature. Leamer uses an empirical Heckscher-Ohlin model' toestimate net trade flows for 183 commodities in 53 countries. 'The differencebetween the actual net trade! and the predicted net trade .. . opt imisticallyreflects the impact of trade barriers on trade.t? To eliminate the effect of thecountry size, this difference is divided by GNP, which yields the adjusted trade

Measurement and Indicators ofOpenness 183

Table A4.3 Measures of openness for the ten sample countries

AT1R J OUTWl RERJ(/982) (/973-85) (/976-85)

Singapore 0.51 (I) 4 IIMalaysia 0.31 (3) 3 8Thailand 0.03 (21) 3 2Indonesia -0.02 (29) 2 38Chilc n.a. 3 25Bolivia n.a. I 94

.Venezuela n.a, n.a. 61Peru -0.21 (52) I 18Guatemala n.a, 2 70Argentina -0.13 (50) I 63

Nole s:I. Leamer's sample consisted of 53 countries (19 industrial market

economies included) . The ATIR is positive if the actual trade shareexceeds the trade share predicted by Leamer's model. whereas negativevalues mean the opposite . The greater the ATIR. the more open thecountry . The numbers in brackets indicate ranks from 1 to 53 wherelower ranks mean stronger outward orientation and vice versa. Ranksfrom 1-18 correspond to an A rating in this survey, ranks from 19-36 toa B, and ranks 37-53 to a C.

2. World Bank (1987). 4 =strong outward orientation; 3 =moderateoutward orientation; 2 =moderate inward orientation; 1=strong inwardorientation. Strong and moderate outward orientation are rated with anA in our survey, whereas moderate and strong inward orientation corre­spond to a Band FC respectively .

3. 95 developing countries were ranked by Dollar (1992) according totheir outward orientation. Lower ranks mean stronger outward orienta­tion and vice versa. Ranks from 1-32 correspond to an A rating in thissurvey, ranks 33-64 to a B, and ranks 65-95 to a C.

intensity ratio (ATIR) : 'The adjusted trade intensity ratio is analogous to ameasure of welfare loss indicating the percentage of GNP lost as a result oftrade barriers' .10

Leamer's indicators of openness are objective, continuous and comparableacross countries but they are only available for the year 1982. They also havesome theoretical limitations: the reliability of Leamer's results depend on thequality of his model to predict trade . The Heckscher-Ohlin model explainstrade patterns with differences in factor endowments and therefore falls short ofcatching the effects of other determinants of trade as differences in preferences

184 Appendix 4

or the presence of scale economies. II A second limitation is the assumption ofthe model that trade impediments, as the only omitted variable of the estima­tion, are uncorrelated with the variables included. This assumption is mostlikely violated."

The ATIR is positive if the actual net trade outweights the predicted net trade,which means that the country in question is more open than predicted by themodel. High values of ATIR therefore correspond to greater openness, whereassmaller and especially negative values stand for a more closed economy . Twoexamples out of the 53 countries in Leamer's sample are quoted here as an illus­tration. In 1982 Peru's TIR amounted to 0.24 which is the same as Switzerland'strade intensity ratio. If the TIR were a correct measure of openness, then Perushould be considered as approximately as open as Switzerland. Looking at theadjusted trade intensity ratio the picture changes dramatically. The ATIR forPeru is now only -0.21 whereas the corresponding rate for Switzerland is+0.08.n Obviously the predicted net trade of Peru outweighs the actual net tradeby far, indicating that despite the country's dependency on trade its resourceendowment suggests that it should be even more open. Of the 53 countries in thesurvey, Peru is the second most closed economy (ranked 2), while Switzerland'sATIRI4 ranks the country at 39. The most open economy, according to theATIR, is Singapore. It should be noted however that Leamer's indicators arerelative measures of openness . Therefore in the case of Singapore the high valueof the ATIR does not imply an absence of trade impediments .

Index of Outward Orientation (OUTW)

This indicator was published in the World Development Report 1987 and con­tained data on 41 developing countries for the periods 1963-73 and 1973-85.The analysed aspects were effective rates of protection, the use of import restric­tions such as quotas and licensing, export promotion policies and the degree ofovervaluation of the respective currencies. IS The World Bank researchersclassified the countries according to their outward orientation and put them intofour categories: strong inward orientation, moderate inward orientation, moder­ate outward orientation and strong outward orientation. The resulting indicators,ranging from one to four, are subjective measure. They are available for nine ofour sample countries. A serious limitation for our research is the World Bank'sdefinition of strong outward orientation which is, to a certain extent, opposed toour own idea of openness: to be strongly outward oriented, according to theOUTW indicator, it is enough for a country that its import restrictions are moreor less offset by corresponding export promoting policies. From our credibilityperspective, such neutrality would look very discretionary .

Dollar's Real Exchange Rate Distortion (RER)

Dollar's (1992) survey of 95 countries also leads to countries being rankedaccording to their outward orientation. Misalignments of the real exchange rate as

Measurement and Indicators of Openness 185

derived from the purchasing power parity theorem and a high variability thereofoffer wrong and inconsistent incentives for those engaged in international trade."

The focus is thus on distortions between domestic and international prices.This picture is, however, complicated by the existence of nontradables. 'Ingeneral , prices of nontradables will differ across countries based on relativefactor endowments '" To use the Summers and Heston price levels to measureoutward/inward orientation ... requires correcting for variation in the indicesresulting from differences in factor endowments. This correction is accom­plished by regressing the price levels on country endowments. The residualsfrom that regression indicate the extent to which a country's prices are high orlow, given the endowments and from these residuals can be constructed across-country index of real exchange rate distortion' .17 The index of realexchange rate distortion is available for all ten sample countries (the measurebeing an average over the period 1976-85).

In order to enable the reader to compare the above openness measures with theratings given in Chapter 6, Table A4,4 shows all indicators converted to ourABC score. How these results were obtained is described in the footnotes to thepreceding tables.

Table A404 Measuresof opennessconvertedinto ABC scores

CCC BMP FDJstocks FDJflows F & S AT/R OU7W REC(/988) (/983-8) (1981-90) (1981-90) (1988)(/982)(/973-85)(/976-85)

Singapore A A A A A A A AMalaysia A A A A B A A AThailand C A C A A B A AIndonesia B A B B B B B BChile B B A B A n.a, A ABolivia B C C C n.a. n.a. C CVenezuela B C C C C n.a, n.a. BPeru C C B C C C C AGuatemala B C B B C n.a, B CArgentina B B B B C C C B

Notes and References

Preface

A businessman's statement as quoted in the Business Section of TheWashington Post, 30 October 1988. Cited in Rodrik, 1989, p. 17.

Introduction

I. Lucas, 1988, p. 5.

1 Catching Up or Falling Behind?

I. All statistics in this paragraph are from World Bank, 1992. The remain­ing 46 per cent and 47 per cent represent the share in services and un­allocated items in Bolivia and Malaysia respectively .

2. The standard assumption is that countries have the same fundamentalparameters, which will be discussed in more detail.

3. For discussion of this point see Romer, 1989, p. 10f. The assumption ofdecreasing returns of capital means that both factors of production areessential for production .

4. For a more detailed theoretical discussion of the role of these parametersin neoclass ical growth models, see Appendix 1.

5. For a discussion see Mankiw, 1992, p. 86f.6. For a survey see, for example, Barro and Sala-i-Martin, 1992.7. Baumol's result seems to be statist ically quite strong. With an estim a­

tion using only one right-hand variable (1870 GDP) his regressionexplains 88 per cent of the variations in the productivity growthrate of labour.

8. See Maddison, 1982, p. 212.9. See the graphical analysis in Barro and Sala-i-Martin, 1990.

10. The sample included Germany (11 regions), UK (11), Italy (20), France(21), Netherlands (4), Belgium (3) and Denmark (3). For the details ofthe results see Barro and Sala-i-Martin, 1991, p. 141ff.

II. The tests have recently been applied to regions within Japan with analo­gous results . In all these studies the rate of convergence was about 2 percent per year. See Barro, Mankiw and Sala-i-Martin, 1992, p. I.

12. See De Long, 1988, p. 1145.13. The list of countries is in Appendix 3.14. The regression results confirm what is obvious from merely looking at

the figure: the initial real per capita GDP and the growth rate of thesecountries are not sign ificantly correlated (r-value of 0.15) and R2 iszero.

186

Notes and References 187

15. For detai Is see Barro, 1991, p. 408ff. Similar regressions have been runby others. See for example Baumol, 1986 and Romer , 1987.

16. For an earlier overview see Sala-i-Martin, 1990.17. For a useful distinction between models with perfect markets, models

with external effects and models with market power, see Barro andRomer, 1990, p. 2ff.

1R. The strict non-convergence result holds for endogenous models with onesector as presented in Rebelo, 1991. In multiple sector models undercertain special conditions convergence can be created . For this point seeMankiw, Romer and Weil, 1992, p. 424.

19. De Long, 1988, p. 1148.20. Other notable contributions are Mankiw , Romer and Weil , 1992, and

Barro, 1991.2 1. For this kind of endogenous growth model see Romer, 1990, and

Grossman and Helpman, 1991a.22. This choice does not imply that endogenous growth models are in any

sense irrelevant for studying economic growth. The endogenisation oftechnological progress is extremely important if the determinants ofworldwide growth potential are analysed . But the problems of develop­ing new technology seems to be clearly more important for industrialisedcountries. Developing countries normally imitate existing technology.Catching up is certainly more relevant for them than becoming techno­logical leaders in the near future.

23. For similar tests of conditional convergence see Barro and Sala-i-Martin,1992.

24. The study by Barro (1991) confirms the success of tests using the levelof human capital as the correction term for showing conditional conver­gence .

25. See Mankiw, Romer and Weil, 1992, p. 433.26. Barro and Sala-i-Martin (1991 , p. 152) conclude that, even for seem­

ingly drastic cases such as southern Italy, they see no evidence tosuggest that poor regions within countries are systemtically left behind inthe growth process .

2 Political Credibility: A Crucial Factor in the Growth Story

I. This example was discussed in Borner, Brunetti and Weder, 1992.2. See Pfeffermann and Madarassy, 1992.3. This is also true for mainstream development policy. The stabilisation

programmes of IMF and the World Bank have been criticised by Rodrik(1989a) for concentrating on the efficiency' of reform proposals andneglecting the problem of their credibility.

4. The term 'Washington consensus' was introduced by Williamson (1990).It reflects the current position of Washington, the IMF and the World Bankas well as of a team of economic advisors with regard to policy reform indeveloping countries . We will discuss this consensus in more detail whenanalysing the policy consequences of our analysis in Chapter 7.

188 Notes and References

5. For a discussion see Brunetti and Weder, 1994a.6. For a survey of the vast literature stimulated by these papers see Persson

and Tabellini, 1990.7. Unemployment is supposed to be high because of labour market

distortions.8. It is assumed that there are two periods. In the first period the private

sector negotiates wage contracts, which are then fixed for the secondperiod. In the second period the government makes a choice of monetarypolicy.

9. The first best outcome would be low wages and surprise inflation, that is.unemployment goes down; the second best outcome is low wages and noinflation, that is, unemployment stays the same; the third best outcome ishigh wages and inflation, that is, stagflation , where unemployment staysthe same; and the worst outcome is high wages and no inflation, that is.unemployment rises.

10. Later works went on to question the credibility of these rules. Whyshould the monetary author ity follow the rule? What is the incentivestructure of this monetary authority? In order to align the incentive struc­ture and the rule, Rogoff (1985) proposed to delegate monetary policy toan independent authority and to pick a conservative as head of thecentral bank.

I I. A second, newer branch deals with wealth taxation . For a survey seePersson and Tabellini , 1990.

12. The term 'protective ' state was introduced by Buchanan (1975) . It ismeant to described the very basic task of a state to provide the twopublic goods - property and contract rights . Our focus will be exclus­ively on this task of the state. It must be distinguished from the 'produc­tive' state that additionally corrects allmarket failures in order to aim forPareto efficiency.

13. The reason being that with differentiated products problems of asym­metric information preva il. Having bought a complicated technicaldevice, you will generally only find out about possible defects later.Therefore you can only assess the real value of the product once it hasbeen used and you no longer have the power to call the deal off.

14. Actually the normal form of this game is the same prisoners' dilemma asthe one shown above.

15. Both private sector strategies analysed here could be called politicallydefensive. An offensive strategy would be to try to associate oneself withthe state and make use of the government's powers - in other words, toengage in rent-seeking. But, while rent-seeking is undoubtedly wide­spread in less developed countries, it is only open to a limited number ofthe privileged and not to the mass of private entrepreneurs.

16. In this simple game the private sector will never produce anything. Thisis a consequence of the assumption of complete information and rationalexpectations on both sides. The result is derived in accordance withthose of the time inconsistency literature on credibil ity. In reality both

Notes and References 189

players will not be completely informed about the payoffs, strategies andincentives of the other party. This leads to the result that some bindingand expropriation of resources will take place.

17. One important aspect to note is that the one-shot game may not ad­equately model the situation. If we consider repeated versions of thegame, with information asymmetries or uncertainty about the number ofrepetitions, or even a infinitely repeated game, the credibility problemcould be overcome . Such reputational effects will be discussed inChapter 5.

18. For a discussion of this example see Pindyck, 1988, p. 969.19. For the theory of the waiting option, see Arrow and Fisher, 1974,

McDonald and Siegel, 1986, and especiaIly Pindyck, 1988, 1991.20. For a more elaborate version of this example, see Pindyck, 199I.21. Pindyck (1988, p, 969) cites a number of empirical studies showing that

waiting to invest pays even in the case of quite smaIl uncertainties.22. See Dornbusch, 1990, p. 17ff.23. For example, Alesina and Tabellini (1989) interpret capital flight as

insurance against potential taxation.24. See De Soto, 1989, p. 12.25. See Sethuraman, 1981, especially the summary ofresults on p. 214.26. For and economic analysis of the family, see Pollak, 1985.27. Ibid., p. 38628. The clubs theory was initiated by Buchanan (1965). For an overview see

Comes and Sandler, 1986.29. Barton, 1983, p. 49.30. For an overview of the role of Chinese traders in South-East Asia, see

the papers in Lim and Gosling, 1983.31. For these and other examples, see Carr and Landa, 1983.32. This is not to say that private enforcement becomes obsolete if a state

acts as third-party enforcer. In fact in all business relations, even inindustrialized countries, the importance of private relationships, trust andreputation can be observed. But in sharp contrast to many developingcountries, these relations do not substitute but complement enforcementby the state . Private relationships in industralised countries are moreefficient because the state as an enforcer is always there as a last resort.Going to the courts may occur seldomly , but as an ultimate threat itenhances the efficiency of all private business agreements.

33. This formulation corresponds to the so-caIled vintage versions of theSolow growth model. See Solow, 1960.

34. The empirical evidence for the link between the rate of investment andthe level of per capita income is strong. Levine and Renelt (1992) con­ducted robustness tests for a large number of variables that could theor­etically affect growth rates. They found that investment is the only realrobust determinate of cross-country differences in growth rates.

35. Romer (1989 , 1990) has postulated that knowledge should not beregarded as a pure public good but as representing a special category of

190 Notes and References

good. A public good is characterised by the fact that it is non-rival in useand that it is not possible to prevent others from taking advantage of it,that is, it is non-excludable. In these terms technology or knowledge is aspecial form of input that is non-rival in use but only partly excludable.Firstly knowledge is definitely non-rival. The fact that I use a certaincomputer software does not prevent you from using the same softwarewithout any loss of its productivity in either case. But with respect toexcludability, technology is distinct from a pure public good. It is to acertain degree possible to keep this good private. I can try to keep myknowledge secret from you or I can protect it by a patent law. Howeverit is impossible to keep it completely private. Nobody can prevent youfrom taking advantage of parts of my technology by trying to imitate myproducts or processes; knowledge is only a partly excludable good.

36. For their original presentation see Grossman and Helpman, 1991b. Theypresent a model that emphasises international trade and spillovers viaexports and imports.

3 Measuring Political Credibility

I. For a recent theoretical discussion and empirical survey, see Sirowy andInkeles, 1990.

2. For a recent discussion of development economics, see Krugman, 1993.3. This is demonstrated by Dick (1974, p. 818), who reports that the entire

literature (of his time) almost unanimously accepted it as a fact that anauthoritarian form of government is more conducive to economic devel­opment. He introduces his empirical study on the type of regime­development link with a quotation from Bhagwati, who forcefully arguesthat totalitarian, socialist governments have clear advantages over demo­cratic ones in carrying out a successful growth-strategy.

4. Although the compatibility approach dominates development economicstoday, the analysis of Olson (1982) stipulates that a stable, long-termdemocracy can reduce economic growth via rent-seeking channels.Nevertheless this point is usually not made for the young, unstable democ­racies of LDCs. Another source of lasting support for the conflict perspec­tive is the fact that the most successful LDCs, the South-East Asian'tigers', happen to have rather authoritarian political systems. We willcome back to this puzzle and present our own solution in our case studiesin Chapter 6.

5. See Brunetti and Weder, 1993a.6. A conditional correlation means that in sum subset or under special

assumptions a positive or negative effect an be found. But this effectonly holds if the data is qualified more or less arbitrarily.

7. Alesina, {)zler, Roubini and Swagel, 1992, p. 14.8. Adelman and Morris, 1967, Feierabend and Feierabend, 1972; Dick,

1974; Huntington and Dominguez, 1975; Russet and Monsen, 1975;Jackman, 1976; Landau, 1986; Sloan and Tedin, 1987.

Notesand References 191

9. Three of the 21 studies surveyed use Bollen's index; Marsh, 1979;Weede, 1983; Kohli 1986.

10. Of the 21 studies. 10 use Gastil 's index: Kormendi and Mequire, 1985;Scully, 1988; Marsh, 1988; Grier and Tullock , 1989; Dasgupta, 1990;McMillan, Rausser and Johnson, 1991; Barro 1991; World Bank, 1990;Alesina et al., 1992; Barro and Lee, 1993.

II . (Gastil , 1989, p. 9). The political rights are: meaningful election of chiefauthority and of legislature, fair campaigning, fair reflection of voterpreference, multiple political parties, recent shift in power through elec­tions, significant opposition vote, no military control, no denial of self­determination for major groups, decentralised political power, informalconsensus. The civil liberties are (p. 17): no censorship , open public dis­cussion, freedom of assembly and of political organisation, rule of law inpolitical cases, no political terrorism, free trade unions, business, privateorganisations, religion, guaranteed personal and socio-economic rights,no gross inequality, no government indifference.

12. This example is detailed in Keefer, 1990.13. See for example, Landau 1986; Aizenman and Marion, 1991; Barro,

1991; Alesina et al., 1992; Barro and Lee, 1993.14. In Rodrik, 1989a, for example, this uncertainty concerns the success

and performance of a major policy reform such as a structural adjust­ment programme. He concludes that the success of policy reform maydepend in no small part on the private sector's expectation of policyreversal.

15. See Brunetti and Weder, 1993a, for details .16. See Alesina et al., 1992; Barro, 1991; Barro and Lee, 1993; Landau,

1986.17. They fit a first-order autoregressive process and take the standard devi­

ation of the residual as a measure of policy uncertainty.18. These variables encompass constitutional rights such as the existence of

a bill of rights, the right to be free from unwarranted searches, to besecure in one's home, to practice a profession, to unionise, to work, toprivacy, to culture and to education. They also include structural politicalvariables such as whether the legislature is bicameral, whether the con­stitution provides the Supreme Court with authority to deal with consti­tutional issues and whether the system of government is federal.

19. See Rosenn, 1984.20. Perhaps the most encompassing and noted systems are the BERt indica­

tor and the World Political Risk Forecasts. For a description of these seeCoplin and O'Leary, 1986, and Dichtl and Koglrnayer, 1986.

21. Some recent studies indicate that in a more disaggregate form the busi­ness indicators could be a useful measure of the political system .Interesting recent efforts to correlate the commercially provided cross­national survey data on subjective country risk evaluations with invest­ment and growth are Mauro, 1993, and Knack, 1993.

22. The complete questionnaire can be found in Appendix 2. See alsoNote 23.

192 Notes and References

23. We managed to gather at least three questionnaires from each of the 28countries, and the average number was eleven. These countries wereArgentina, Bolivia, Brazil , Cameroon, Chile, Colombia, Costa Rica,Ecuador, Ghana , Guatemala, India, Indonesia, Jordan, Malaysia,Mexico, Mozambique, Nigeria, Panama, Peru, Rwanda, Senegal,Singapore. Sri Lanka, Sudan, Tanzania. Thailand, Turkey, Venezuela.

24. The trend question of our questionnaire was rated I (decrease in uncer­tainty during the last ten years) to 3 (increase in uncertainty during thelast ten years). If the value of the responses to this question was larger(smaller) than 2, the earlier value was decreased (increased) according tothe formula: POLCRED8185 = POLCRED8690 + 2(2-TREND) . Thevariable POLCRED8690 is the value of our political indicator as calcu­lated from the questionnaires and is interpreted as the value of 1986-90.TREND is the average value of the responses to the trend question, andPOLCRED8185 is the resulting earlier value, interpreted as the value for1981-5. For the countries where our country sample was small. that isthree to five questionnaires, the correction coefficient was lowered. Theearlier value of those countries was obtained from: BBW8185 =BBW8690 + (2-TREND). The average of BBW8185 and BBW8690 isused in the regressions as indicator of political credibility, BBW8190,for the time period 1981-90. The position of these boundaries does notinfluence the results presented in the next chapter.

25. The growth rates were calculated from Summers and Heston, 1991.26. See Shleifer and Vishny, 1993, and Klitgaard, 1990.27. For details see the questionnaire in Appendix 2. Questions 1-6 concern

the bureaucracy , and questions 12-16 concern the judiciary .28. For smaller businesses, however, the bureaucratic uncertainties may still

be extremely relevant because they work on a break-even margin andcannot afford to buy the services of tramidatores . Larger companies inmany developing countries tend to employ some tramidatores .

29. We have discussed these private enforcement mechanisms in some detailin Chapter 2.

4 Political Credibility and Economic Growth: The EmpiricalEvidence

1. Of course there could be a causality problem in this regression. It couldbehypothesised that economic success, that is, growth, leads to politicalcredibility. With this kind of regression the direction of causation is notdetermined . Nevertheless we have arguments as to why political credi­bility causes economic growth. First our theoretical analysis in Chapter 2provides different arguments as to why higher political credibility causesmore investment and higher specialisation, which both enhance econ­omic growth. It would bedifficult to argue the other way round. Secondwe have made a causality test by regressing economic growth from1986-90 on our political indicator for the period of 1981-6. The political

Notes and References 193

cred ibility of the earlier period was significantly correlated with thegrowth rate of the later period. The principal problem of our sample isthat we have no long-term time series data on political credibility thatwould enable us to carry out more refined causality tests. But ultimatelyour analysis , working with average values of the most important vari­ables, follows in essence the mainstream empirical cross-country growthanalysis developed in the last decade.

2. PRIM80 and HSEC80 are from UNESCO, 1990 and GDP80 is takenfrom the Summers and Heston, 1991 data set.

3. The results of the indicator of political credibility in all folIowing regres­sions hold when this richer specification is applied.

4. In Brunelli and Weder, 1994b, we test the robustness of POLCRED onprivate and total investment by including other right-hand variables suchas inflation, human capital variables, government share in GDP and otherpolitical variables. POLCRED proves to remain significantly associatedwith private and total investment in these richer specifications.

5. Note that the number of observations for the political instability indica­tors is only 27 as Mozambique is missing for the BarrolWolf measures.

5 Explaining Political Credibility: Conceptual Foundations

I. Adapted from Olson, 1991.2. · Hobbes, 1651, p. 131.3. Real-world situations are not characterised by complete information. In

the narrow framework of our model reputation is not the game-theoreticcorrect term. Because there is no uncertainty in the game, there is also noincentive to try to convince the other player of anything, that is, build areputation. Therefore the term 'reputation' is usually used in a broadersense than that in the narrow game-theoretic concept.

4. We are assuming that the private sector could be fooled once but wouldthen withdraw into subsistence.

5. TulIock, 1987, Chapters 2-4.6. See Grossman, 1991, for a model of insurrections in which the active

insurgents share the booty taken in a successful insurrection and wherethe credible threat of overthrow by outsiders leads the government topursue a relatively more benevolent tax policy.

7. De Long and Shleifer, 1993, p. 700.8. See Tullock, 1987, p. 24 ff.9. One problem with this strategy is that it will tend to generate false

alarms.JO. See Willman, 1989, for a discussion of this point.II. Hirschmann, 1981, Ch. II .12. See Tiebout, 1956.J3. Quoted in Sinn, 1992, p, 178.14. See Sinn, 1992.15. See Jones, 1980.

194 Notes and References

16. Hirschmann, 1981, p. 253.17. Montesquieu, quoted in Hirschmann, 1981, p. 255.18. See, for example, Little, Scitovsky and Scott, 1970, and Krueger, 1978.19. For details of measurement of openness see Appendix 4.20. For a discussion of this point, see Zippelius, 1987, p. 302.21. See for example Frey, 1981.22. See Olson, 1965, and, for an encompassing summary, Mueller, 1989.23. This is in marked contrast with indirect democracies. In indirect democ­

racies the private agent can only vote once every four years or so on theaggregate decisions of the incumbent party. In a direct democraticsystem most decisions of the government or parliament can be chal­lenged by popular vote.

6 Sources of Political Credibility in Ten Countries

1. For details see Appendix 4.2. For a detailed discussion see Appendix 4.3. Direct democracy - the third channel of vertical separation of power - is

absent or completely unimportant in all case study countries. We there­fore abstain from discussing this point in the following analysis.

4. See Appendix 2.5. See Appendix 2.6. For all countries data on economic performance was obtained from the

following: Summers and Heston, 1991, for average economic growth,World Bank, 1992, for average inflation and Pfeffermann andMadarassy, 1992, for average private investment. Political performanceis the average POLCRED indicator described in Part I of this book.

7. It is interesting to note that Goh Chok Tong has appointed a son of LeeKuan Yew, Lee Hsien Loong, as deputy prime minister.

8. Papageorgiou, Michaely and Choksi, 1991.9. World Bank, 1987 and Dollar, 1992; for details see Appendix 4.

10. World Bank Policy Research Report World Bank, 1993, p. 184.II. For its composition see Banks, 1992, p. 476ff.12. For details see Appendix 4.13. For a summary of this GAIT country survey see Neue ZUrcher Zeitung,

1993, no. 183.14. According to Freedom House (1993, p. 350) however, 'the Malaysian

Bar Council has been at odds with the government since 1988... In 1992,the Bar Council continued the standoff by refusing to recognize thecurrent Lord President' .

15. In 1992 it was even lowered to 5.16. See Chai-Anan and Sukhumband, 1993, for a discussion of the political

system of Thailand.17. Papageorgiou, Michaely and Choksi, 1991.18. World Bank, 1987; for details see Appendix 4.19. Freedom House, 1993, pp. l7o-1.

195Notesand References

20. Papageorgiou. Michaely and Choksi, 1991.21. Ibid.22. Banks. 1992, p. 146.23. There have been over 180 coups during the 157 years that have elapsed

since Bolivia gained its independence from Spain in 1825. The armyreturned to barracks only in 1982.

24. Freedom House. 1993. p. 135.25. At the same time the number of ministries was reduced from 17 to 10;

see Neue ZUrcher Zeitung; 1993, no. 182.26. Two indigenous guerilla movements have recently emerged. They are

said to have connections with drug traffickers and the Peruvian SenderoLuminoso.

27. Nairn, 1993, p. 45.28. See Hausmann, 1990, p. 227.29. EI Nacional, 5 March 1993.30. Leamer's sample consists of 53 countries; for details see Appendix4.31. Data are available only until 1985; for details see Appendix 4.32. Banks.1992, p. 305.33. For a discussion of this see ibid.34. Freedom House, 1993, p. 252.35. Papageorgiou, Michaely and Choksi, 1991.36. The fact that the industrialised countries are not necessary the fastest

growers is in line with the growth theory described in Chapter 2.Because industrialised countries have already attained high levels of percapita GDP, they are closer to the highest possible steady state. whichimplies lower growth rates.

37. Excluding Chile.

7 Implications for Policy Reform

I. For details see Williamson, 1990.2. For details see Borner. Brunetti and Weder, 1993.3. See Killick, Malik and Manuel, 1992.4. Williamson, 1990. p. 5.5. See Pfeffermann and Madarassy, 1992.6. Williamson, 1990. p. 33.7. See also Borner. Brunetti and Weder, 1993.8. A pinata is actually a birthday party game in which children beat a figure

with sweets. As soon as the sweets begin to fall out everybody grabs asmany as she can.

9. World Bank, 1992.10. Ibid., p. 50 ff.II. See Serageldin, 1993, p. 7.12. World Bank. 1992. p. 18.13. Ibid.• p. 45.14. See Nunberg, 1990, p. 12.

196 Notes and References

15. See Knotter, 1991, p. 154.16. See World Bank, 1992b, p. 3717. See World Bank, 1992b,p. 31, for a moredetailedaccountof these projects.18. See World Bank, 1992b, p. 33, for some examples in Eastern European

countries .19. See De Soto, 1989.20. Poor protection of land property in rural areas is a widespread problem

in many LDCs. The World Bank has supported programmes to updaterural land registers in several countries. Bringing economically margin­alised groups back into the formal system has also been the effort ofother development organisations. For example FUNDES, a Swiss non­governmental organisation, is supporting small and medium-sized entre­preneurs in Latin America. FUNDES offers guarantees for credits, whichwould not be given through the formal banking system, and helps smallentrepreneurs to obtain legal titles to their businesses, which can then beoffered as collateral.

21. See Funke, 1993, p. 340.

Appendix 1

I. For a discussion of the Solow model see Sala-i-Martin, 1990, pp. 4ff.2. This formulation, with a constant rate of saving, corresponds to the orig­

inal Solow approach . Refinements consider a representative consumerwho maximizes and intertemporal utility function . In these versions,which dominate the actual vintage of growth models, the savings rate isan endogenous result of this optimisation and is therefore ultimatelydriven by the preferences of the representative consumer. For a textbooktreatment see Sala-i-Martin, 1990.

3. Expressing all variables in per capita terms not only simplifies the fol­lowing discussion, but per capita income is a much better measure of'wealth' than simply using aggregate income. If an economy grows at arate of 10 per cent its growth performance seems to be impressive. But ifat the same time the population grows by 20 per cent, e.g, because of animmigration boom, people clearly become worse off. Working in percapita terms eliminates this difficulty.

4. See Sala-i-Martin, 1990, p. 37.5. Put formally,A(t) =A(O)e8'. The parameterg is the productivity growth rate.6. In the steady state, output per capita grows at rate g and total output

grows at rate n + g.

Appendix 4

1. Quoted from World Currency Yearbook, (International CurrencyAnalysis), 1988-9, p. 18.

2. Ibid., p. 23

Notes and References 197

3. Fischer, 1993, p. 16.4. Sources for the data are UNCTC. 1983 and IMF, 1993.5. See Frost & Sullivan, 1988.6. Agarwala , Gubitz and Nunnenkamp, 1991, p. 35; this unweighted

average of nine criteria is used for our survey too (see ibid.• p. 36).7. This model uses the following factors: capital. three types of labour. four

types of land, plus oil, coal and minerals as well as distance to tradingpartners and net trade balance.

8. Actual net trade or trade intensity ratio (TIR) is defined as the differencebetween exports and imports divided by GNP.

9. Leamer. 1988, p. 163.10. Ibid.• p. 164.11. For this point see Brown's comment on Leamer's article in ibid., p, 202.12. See Edwards, 1992, p. 41: 'For these reasons in this paper I take the

view that the Leamer indexes are imperfect proxies (although I think thebest currently available ones) of the theoretical trade intervention andtrade distortion indices' .

13. These data are obtained from the scaled or heteroskedastic model, whichfits the smaller countries better than the unsealed model, according toLeamer. See Leamer, 1988, for a discussion on the use of thehomoskedastic or heteroskedastic trade model.

14. If the TIR were used to rank the countries, Peru would be ranked 22 andSwitzerland 20. According to Leamer (1988, p. 183) the adjustment ofthe trade intensity ratio makes the less-developed countries appear lessopen, whereas the measure for the industrial market economies tends toadjust in the opposite direction.

15. According to the World Bank an inward orientation of a country is nor­mally combined with overvaluation.

16. 'Misalignment is an over- or undervaluation of the real exchange ratethat is unsustainable, given the overall policy package (including thetrade regime). Misalignment. however, does not reflect an economy'slong-run trade orientation. For instance, there are many Africaneconomies that have real exchange rates that are overvalued in the sensethat they provide weak incentives to export. These exchange rates,however, are supported by strong import protection and are often quitestable in real terms over long periods of time', (Dollar, 1992, p. 524).

17. Dollar, 1992, p. 526.

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IndexAfrica, informal sector 31Agarwala, J. 182Aizenman,J. 43,44Alesina, A. 41anarchical societies 20-3

defined 20and informal sector 30-3,34personal enforcement 31-3,34prisoners' dilemma 21,22, 23,

24transactional uncertainty 22-3vulnerabilityof possession 20-1,

23Argentina 50, 142-5

capital control 143, 180credibility 55-8, 142-5,178;

sources of 105economic performance 56, 57,

58, 142foreign direct investment 182openness 142,143-4,183,185political system 142-3reputation 142-3separation of powers 144-5

Aristotle 100Asia see South-East Asiaassassinations 69-70authoritarian regimes

and growth 42, 190and political certainty 46-7

bandits 88competing 79-80roving and settled 77-81

Bangladesh 161banks 48,49Banks, A. 108Barro, R. 12, 18, 63, 187

on convergence 9, II, 14on political indicators 43, 45,

69-70Baumol, W. 8-9, 10, 186

black market premium seeexchange

rateBolivia 16-18,19,127-30,195

capital control 128-9, 180credibility 55-8, 127-30, 145,

178;sources of 105development pattern 3economic performance 56, 58,

127, 128foreign direct investment 182investment 151openness 128-9, 180, 183, 185political system 17-18,127power of state 17, 18property rights 17reputation 128

Bollen, K. 39Brazil 53

credibility 178policy surprises 60

bribery see corruptionand briberyBrunetti, A. 64, 193Buchanan, J. 188bureaucracy 108

Argentina 145Bolivia 130Guatemala 141-2Malaysia 116Peru 137-8Singapore 112Thailand 116Venezuela 134

Cameroon 178capital control 96, 106, 179-81

Argentina 143Bolivia 128-9by country 180Chile 125Guatemala 139Indonesia 121-2

207

208

capital control cont.Malaysia 114Peru 136Singapore 110Thailand 118Venezuela 132

capital flight 30,41-2,92-4capital, returns to

endogenous growth model 12neoclassical growth model

12-13,169-71catching up see convergence;

neoclassical growth modelcentral banks 48, 49Chamorro government 150

and property rights 155-6Chile 123-7

capital control 125, 180credibility 55-8, 123-7, 145, 146,

147, 178; sources of 105economic performance 56, 58,

123-4foreign direct investment 182openness 183, 185political system 123, 124reputation 124-5separation of powers 126-7

Choskl, A. 136civil liberties 40,191civil servants 173-4

see also bureaucracycollusion 99Colombia 178conditional convergence see

convergenceconflict theory 38constitution 47-8, 191

Chile 127consultation 115-16

Argentina 144-5Bolivia 130Guatemala 141Indonesia 123Malaysia 116Peru 137Singapore 111-12Thailand 118, 119

Index

Venezuela 134contracts

and ideal state 23-5private enforcement 31-3 ,34,

60, 189convergence 6-11,186,187

conditional 11-12, 13-14evidence of 8-11and exogenous 7, 171explaining non-convergence

11 -13neoclassical growth theory 6, 7political factors 14-15and steady state 12-13,171,195testing for 13-14

corruption and bribery 49examples 51and political credibility 58-61questions on 176-7Thailand 59

Costa Rica 178coups 69-70, 195

Cukierman, A. 42, 48, 49currency control 96, 106

categories 179-80

De Long, B. 8, 10, 12,84, 85de Soto, H. 31, 157, 163De Vanassy, X. 47debt, external, and political

instability 42decentralisation 165democracy

Chile 125, 126, 127direct 104, 194and discretionary power of state

17-18and growth 37-41,42,55-8indicators and political credibility

55-8,71interest groups 102-3measuring 39-41and political instability 46stable party systems 87-90see also participation

developing countriesconvergence 11

family governance 31-2federalism 104. 107financial markets 161fiscal policy 152foreign direct investment 49. 107

Argentina 143Bolivia 129Chile 125as exit threat 181Indonesia 122Malaysia 114Singapore 110stock and annual flow 181, 182Thailand 1I8and Washington consensus 153

foreign exchange see exchange rateFrost and Sullivan index 1I0.181,

182FUNDES 54. 196

Gast il, R.lindicator 39-40,41,45,56-8

and POLCRED compared 69-70political rights defined 191scoring 68temporal separation of power

108Germany 7, 157Ghana 178GNP per capita, hypothetical levels

under differing growth rates4-6

Gordon, D. 18governance 157-65

bottom-up approach 162-5and judiciary 160-1and legal framework 161-2and political credibility 166and public administration 159-60top-down approach 158-62

sequencing of reform 167-8state discretionary power 25-6

Dick, W. 190dictatorships

barriers to emigration 93benevolent 16. 18Chile 123. 124-5and discretionary power of state

18Indonesia 120long-serving and GDP 86Malaysia 113Peru 135Singapore 108stable 84.86-7succession problem 87survival probability 82Thailand 116

Dollar . D. 136.181 .183.184-5Dowrick, S. 9

East Germany 157economic policy making

and political instability 41-2Washington consensus 151-2

Ecuador 178Edwards. S. 42elections 98,99, 102, 107.108

and measurement of democracy39.40

and measurement of instability45-6

and political credibility 87-8see also party system

emigration restriction 93-4empowerment 163, 164-5endogenous growth theory 11-13England. succession of monarchy

85,88entitlement, informal sector 163-4Europe, monarchies 84exchange rate

distortion 107. 184-5and policy reform 152-3premium 96.106.180-1Argentina 143Bolivia 129

Index

Chile 125Guatemala 139Indonesia 121

execut ive power 98control of 101exit 87,91-7, 146, 179-85

209

210

government see stateGrossman, G. 35Grossman, H. 193growth

and democracy 37-41, 42. 55-8determinants 64and enforced rules 33Latin America and South-East

Asia compared 4. 5and political credibilitycosts of low 33-6empirical'evidence 62-71and political stability 41-7and technology J2see a/so convergence; neoclassical

growth modelGuatemala 50, 88, 138-42capital control 139, 180credibility 55-8. 138-42, 145.

178sources of 105foreign direct investment 182growth 56, 58openness 138, 139-40, 183. 185political leaders 89-90political system 138reputation 138, 139

Gubitz, A. 182

Hausmann. R. 180Helpman, E. 35Heston, A. 63, 185, 194hierarch ies 103-4. 107Hirschmann, A. 91Hobbes. T. 20. 23. 78, 79

India 178Indonesia 51.53,60,120-3capital control 125. 180credibility 55-8. 120-3, 145.

147, 178sources of 105

economic performance 120foreign direct investment 182growth 56.57. 58openness 120. 121. 183. 185

Index

political system 120-1. 122reputation 120-1separation of powers 122-3

informal sectoreffect on growth 35-6entitlement 163-4limits of 33and low political credibility 30-3

institutions 50-I, 52-3 . 55-61and sequencing of reform 167-8

interest groups 98, 99, 107Bolivia 130as check on power 102-3Chile 127consulat ion 108Guatemala 141and participation 166rent-seek ing 103Singapore 111-12Thailand 119

International Monetary Fund 149,161,187

investment 150-1and convergence 14effect of political instability 41and growth 189and neoclassical model of growth

169Nicaragua 154and policy surprises 53and political credibility 27cross-national analysis 65-8effect of low 28-30, 34-5. 36private vs. state 67as robust determinant of growth

65and Washington consensus 153seealso foreign direct investment

Italy 46

Japan II. 13, 186growth 7steady state 15

Jodice, D. 43Jordan 178judiciary 98

control of 101-2

Index 211

corruption 51, 60and governance 160-1reform 160-1

Klitgaard, R. 157Kronman, A. 20Krueger, A. 95Kydland, F. 18, 19

Latin Americaconstitutions 48credibility 147-8democracies 88

and instability 46dictatorships 86, 88, 89-90growth performances 3-4, 5

and political credibility 55-8informal sector 31see also individual countries

LDCs see developing countriesLeamer, E.ltrade intensity ratio

107, 181-4Malaysia 114Singapore 110Thailand 118

Lee Kuan Yew 109, 112legal framework/system 51

control of legislative power 98,101

questions on 173-7reform of 161-2, 167and sequencing of reform 167

Levine, R. 43,65, 189Locke, John 100Lucas, R. xii, II

Madarassy, A. 66, 194Maddison, A. 8-9, 10Malaysia 113-16,194

capital control 114, 180credibility 55-8, 113-14, 145,

147, 178sources of 105development pattern 3foreign direct investment 182growth 56,57,58, 113openness 113, 114-15, 183, 185

political system 113, 114, 115reputation 113-14separation of powers 1I5 , 1I6

Mankiw, G. 14Marion, N. 43, 44market economy

promotion of 38Washington consensus on 151,

153market size 30-3, 34-6Mexico 178

political factors and growth 15Michaely, M. 136monarchies

English succession 85, 88Europe 84reputation 75, 76, 78-9, 83-4succession problems 84

monetary policy 49, 188and credibility 18-19

Montesquieu, Charles de 100Mozambique 178multinational companies 49-50

capital flight 93exit 79,93,94

neoclassical growth model (Solow)6-14, 169-71, 187, 196

and convergence 6,7, 11-13,171

exogenous shocks 7,171production function 7and returns to capital 12-13,

169-71and technology 7versus endogenous growth theory

11-13see also convergence

Neyapti, B. 48, 49Nguyen, D. 9Nicaragua

credibility 156property rights 154-7stabilisation programme 150transactional uncertainty 156-7

Nigeria 178Nunnenkamp, P. 182

212

OECD countriesconvergence IIsteady states 13

Olson, M. 77, 190openness 75,91-7,105

Argentina 142, 143-4Boliv ia 128-9Chile 125-6Guatemala 138, 139-40Indonesia 120, 121long-term effects 94-5, 96maintenance of 95Malaysia 113,114-15measurement and indicators of

106-7, 179-85Peru 135, 136short-term effects 92-4, 95-6Singapore 110Thailand 116,117,118Venezuela 132outward orientation 151, 152-3index of 107,184seealso openness

Ozier, S. 42

Panama 178Papageorgiou, D. 136participation 37,88,90

Argentina 142, 144-5Bolivia 129-30Chile 124, 126control through 75, 76, 80, 105,

166-7channels 107-8credibility through 97-104

forms of 99-104problems of 98-9

and decentralisation 165Guatemala 138, 140-2Indonesia 122Malaysia 113, 115-16measuring 107-8Peru 135, 136-8Singapore 111-12Thailand 118Venezuela 132-4see also consultation; democracy

Index

party system 87-90, 98, 167Argentina 144Chile 125Guatemala 140-1Latin America 148

and reputation 90Singapore I08Venezuela 131-2,133-4

Peru 51,134-8,184,195capital control 136, 180credibility 55-8, 134-8, 145,

178; sources of 105foreign direct investment . 182growth 56,57,58,134-5informal sector 31, 164openness 135,136,183,185participation 136-8per capita GNP 4, 5, 6political system 134, 135, 137reputation 135

Pfeffermann, G. 66, 194Pinochet, General 124-5, 126Plato 100POLCRED 54, 192, 193

rating by country 105, 178statistics 63-4, 66-8versus other indicators 68-70see also political credibility

policy making 41-2,151-2and ideal state 25monetary 18-19,49,188predictability 52-3

policy reformand credibility 18,19,157implications of traditional

approaches 149-68seealso Washington consensus

political credibilityand business indicators 49-50by country 178conceptual foundations 75-104and control mechanisms 105and corruption 58-61as crucial to growth 16-36and democracy, low correlation

55-8and economic policy making 18

213

establishment of 165-8and governance 166and growth 192

empirical evidence 62-71testing effect 63-5

indicator 51-61construction of 54-5

and investment 27lack of 26-8

growth costs 33-6private sector responses 28-33

measuring 37-61and monetary policy 19and policy making 25Singapore 109-10sources of 75-6. 77-90

by country 105-48sustaining 147through participation 97-104versus other political variables

68-70see also POLCRED; state

political rights 40Chile 126defined 191

political stabilityalternative indicators 68-70and convergence 14-15definitions 43and democracy 46and growth 41-7measurement of 43-4

limitations 44-7Portugal 10power

decentralisation of 104separation of 98-104Argentina 144-5Bolivia 129-30checks and balances 98. 100-1Chile 126-7horizontal 98. 100-3, 107-8Indonesia 122-3Latin America 148Malaysia 115, 116principle of incompatibility 101Singapore 111,112

Index

temporal 98, 107, 108Thailand 118-19Venezuela 132-4vertical 98,99,103-4, 107, 108see also party system; state

Prescott, E. 18, 19pressure groups 164-5prisoners'dilemma 21,22,23,24private sector

examples of experiences 50-I,53,58-60

and policy uncertainty 44-6responses to low political

credibility 28-33informality 30-3investment decisions 28-30Singapore 111-12and state

as player in game model18-19,26-8,77-83,91-2,188-9

Thailand 119withdrawal 76,79, 80, 83-90

costs 91privatisation

Nicaragua 150public enterprises 160and Washington consensus 153

property rights 167, 188, 196Bolivia 17and constitutions 47-8and ideal state 23Nicaragua 154-7

protectionism 95public enterprises privatisation 160public expenditure 152public goods 188, 189-90

questionnaire 172-7answers 50-1,110,127,134,

137-8,141;Argentina 145;Guatemala 141 ;Peru 137-8;Venezuela 134

on corruption 58-9, 134distribution 54. 192

214

questionnaire cont.political credibility indicator 52quest ions 51-3,108trend question 192

reform, sequencing of 167-8see also policy

Renelt, D. 43,65, 189reputation 75, 76, 105, 147

Argentina 142-3Bolivia 128Chile 124-5conditions for 81-90and credibility 166-7Guatemala 138, 139Indonesia 120-1internal withdrawal 80, 83-90Malaysia 113-14measuring 106Peru 135as settled bandits 78-9Singapore 109-10stable monarchies 83-4survival of head of state 81, 82-3Thailand 116, 117Venezuela 131-2

research and development 13, 34see also technology

resource allocat ion 62, 68revolutions 69-70riots 69-70Rodrik, D. 187, 191Rogoff, K. 188Romer, D. 14Romer, P. 11,12,189ruleoflaw 191Rwanda 178

Sala-i-Martin, X. 9,12,14,187, 196Sandinista government 150, 155,

156Senegal 178Shining Path 51Shleifer, A. 84, 85Singapore 108-13,184

capital control 180centralisation 112

Index

credibility 55-8, 145, 147, 178rating 109, 110sources of 105

foreign direct investment 182growth 4, 56, 57, 58, 109openness 110, 183, 185reputation 109-10separation of powers III

Smith, A. 92Solow, R. 6-7,47

and conditional convergence13-14

neoclassical model of growth169-71, 196

South-East Asiacredibility 146, 147

and growth 55-8dictatorships 87economic performance 3-4, 5informal enforcement 32-3informal sector 31private sector withdrawal 87property rights 46regimes and growth 190see also individual countries

specialisation 62, 65and exit 96-7international 94, 96see also technology

Spindler. Z. 47Sri Lanka 178stabilisation programmes 150, 151,

187state

autonomous 147collusion 99discretionary power 19

Bolivia 17-18and democracy 17-18examples 50-1LDCs 25-6needtoreduce 36and political credibility 26-8

ideal 23-6and game with private sector

18-19,26-8,91-2protective 20-6, 188

Index 215

punishment for abuse of power75-6

rule enforcement 23-5separation of powers 98,99-104stateless societ ies 20-3survival probability of head of

81.82-3see also anarchical societies ;

democracy; political stability;power

structural adjustment programmes150,151

and price deregulation 153and private sector expectations

191reform of government pay systems

160Sudan 178Suharto, President 120-1Summers, R. 63, 185, 194sun yung 32-3Switzerland 184

Tabellini , G. 41-2Tanzania 178tariffs and policy reform 153tax

assessors 50inflation 83reform 152and reputation 81

Taylor, C. 43technology 190

effect of low credibility on 34,35-6

and growth 65, 187;theory 7,12,13,14,15,169-71

Thailand 46-7, 116-19capital control 118, 180corruption 59credibility 55-8,116, 145, 178;

sources of 105foreign direct investment 182growth 56, 57, 58, 116openness 116,117,118,183,185political system 116, 117

reputation 116, 117separation of powers 118-19

tradeIiberalisation 152-3 , 167outward orientation 94policy 97protectionism 95restrictions 95,96-7

trade distortion 97Argentina 143-4Bolivia 128, 129Chile 125,126Guatemala 140index of 107Indonesia 122Malaysia 115Peru 136Singapore 110Thailand 118Venezuela 132

tramitadores 60transactional uncertainty 21-3,

156-7Tullock, G. 82, 84Turkey 178

United Statesconvergence 9political factors and growth 15

Venezuela 130-4, 178capital control 180credibility 55-8, 130-4, 145;

sources of 105foreign direct investment 182growth 4,56,58,131openness 132, 183, 185participation 132-4political system 130-1reputation 131-2separation of powers 132-4

Vietnam 32-3

Washington consensus 18,149-57,187

free market capitalism 151, 153institutional dimension 154-7

216

Washington cont.outward orientation 151, 152-3prudent macroeconomic policies

151-2Webb, S. 48,49Weder, B. 64, 193Wei!, D. 14

Index

West Germany 157Williamson,J. 149,151-2,154,18'1Wolf, H. 43,45,69-70World Bank 149, 187, 196

on decentralisation 165on governance 157-8,159-62on rule of law 161-2