Working Papers
2012
March 1, 2012
Institutional Transformations, Polity and Economic Outcomes: Testing the North-Wallis-Weingast Doorsteps Framework
Description: This paper tests the theoretical framework developed by North, Wallis and Weingast (2009) on the transition from closed to open access societies. They posit that societies need to go through three doorsteps: (i) the establishment of rule of law among elites; (ii) the adoption of perpetually existing organizations; and (iii) the political control of the military. We identify indicators reflecting these doorsteps and graphically test the correlation between them and a set of political and economic variables. Finally, through Identification through Heteroskedasticity we test these relationships econometrically. The paper broadly confirms the logic behind the doorsteps as necessary steps in the transition to open access societies. The doorsteps influence economic and political processes, as well as each other, with varying intensity. We also identify income inequality as a potentially important force leading to social change.
March 1, 2012
Fiscal Devaluation and Fiscal Consolidation: The VAT in Troubled Times
Description: This paper focuses on two core tax design issues that arise in addressing current fiscal challenges. It first explores the idea, prominent in troubled Eurozone countries, of a "fiscal devaluation": shifting from social contributions to the VAT as a way to mimic a nominal devaluation. Empirical evidence is presented which suggests that in Eurozone countries this may indeed improve the trade balance in the short-run, though, as theory predicts, the effects eventually disappear. The paper then assesses the wider scope for VAT reform in meeting fiscal consolidation needs, developing and beginning to apply a methodology for finding additional VAT revenue in ways less distortionary and fairer than further raising the standard rate.
March 1, 2012
Trade and Financial Spilloveron Hong Kong SAR from a Downturn in Europe and Mainland China
Description: Hong Kong SAR was hit hard by the global financial crisis, which started out in the U.S. and spilled over to the rest of the world. Three years later, vulnerabilities in the euro area's financial system and concerns over a hard landing in Mainland China have started to weigh on Hong Kong's growth prospects. Against this backdrop, this paper aims to quantify the trade and financial spillovers on Hong Kong SAR's economy from a downturn in the euro area and Mainland China. Based on simulations using a version of the Global Integrated Monetary and Fiscal (GIMF) model and a Global VAR (GVAR) that includes both balance sheet and standard macroeconomic indicators, Hong Kong SAR's output growth could fall by as much as 1½ times the decline in euro area output growth given its high dependence on external trade and many links with the global financial system. A worsening of the crisis in the euro area could reduce Hong Kong SAR's output by as much as 4-4½ percent below baseline during the first two years after the shock, pushing Hong Kong SAR back into recession and possible deflation. In the event of a hard landing in China, the model simulations suggest that Hong Kong SAR would be on a sustained downturn with output growth falling by about 3 percentage points below baseline in the first two years. Should these events materialize, countercyclical fiscal response could help cushion, but not fully offset, the impact of slower growth in the euro area or China.
March 1, 2012
Determinants of Corporate Investment in China: Evidence From Cross-Country Firm Level Data
Description: This paper analyzes the evolution of investment in China, its main features, and its key determinants. In recent years, manufacturing, real estate, and infrastructure have been the main drivers of investment. Investment remains largely concentrated in coastal areas, but there has been a shift to greater investments inland in recent years. The empirical analysis of the determinants of investment indicates that financial variables, such as interest rates, the exchange rate, and the depth of the domestic capital market are important determinants of corporate investment. The results suggest in particular that financial sector reform, including that which deregulates and raises real interest rates as well as appreciates the real effective exchange rate, would lower investment and help rebalance growth away from exports and investment toward private consumption.
March 1, 2012
Strengthening Russia's Fiscal Framework
Description: Though many aspects of Russia's fiscal policy framework are close to best practice on paper, actual practice in recent years has been moving away from best practice. In particular, the continued focus on the overall rather than the nonoil balance, and the regular use of supplemental budgets to spend windfall oil revenues contribute to procylicality of fiscal policy, risking costly boom-bust cycles. Against this background, this paper suggests several improvements to the framework for fiscal policy.
March 1, 2012
Capital Regulation, Liquidity Requirements and Taxation in a Dynamic Model of Banking
Description: This paper studies the impact of bank regulation and taxation in a dynamic model with banks exposed to credit and liquidity risk. We find an inverted U-shaped relationship between capital requirements and bank lending, efficiency, and welfare, with their benefits turning into costs beyond a certain requirement threshold. By contrast, liquidity requirements reduce lending, efficiency and welfare significantly. The costs of high capital and liquidity requirements represent a lower bound on the benefits of these regulations in abating systemic risks. On taxation, corporate income taxes generate higher government revenues and entail lower efficiency and welfare costs than taxes on non-deposit liabilities.
March 1, 2012
Does the Business Environment Affect Corporate Investment in India?
Description: Since the global financial crisis, corporate investment has been weak in India. Sluggish corporate investment would not only moderate growth from the demand side but also constrain growth from the supply side over time. Against this background, this paper analyzes the reasons for the slowdown and discusses how India can boost corporate investment, using both macro and firm-level micro data. Analysis of macro data indicates that macroeconomic factors can largely explain corporate investment but that they do not appear to account fully for recent weak performance, suggesting a key role of the business environment in reviving corporate investment. Analysis of micro panel data suggests that improving the business environment by reducing costs of doing business, improving financial access, and developing infrastructure, could stimulate corporate investment.
March 1, 2012
How Do Exchange Rate Regimes Affect Firms' Incentives to Hedge Currency Risk? Micro Evidence for Latin America
Description: Using a unique dataset with information on the currency composition of firms' assets and liabilities in six Latin-American countries, I investigate how the choice of exchange rate regime affects firms' foreign currency borrowing decisions and the associated currency mismatches in their balance sheets. I find that after countries switch from pegged to floating exchange rate regimes, firms reduce their levels of foreign currency exposures, in two ways. First, they reduce the share of debt contracted in foreign currency. Second, firms match more systematically their foreign currency liabilities with assets denominated in foreign currency and export revenues--effectively reducing their vulnerability to exchange rate shocks. More broadly, the study provides novel evidence on the impact of exchange rate regimes on the level of un-hedged foreign currency debt in the corporate sector and thus on aggregate financial stability.
March 1, 2012
Labor Market Flexibility and Unemployment: New Empirical Evidence of Static and Dynamic Effects
Description: The aim of this paper is to analyze the relationship between labor market flexibility and unemployment outcomes. Using a panel of 97 countries from 1985 to 2008, the results of the paper suggest that improvements in labor market flexibility have a statistically and significant negative impact on unemployment outcomes (over unemployment, youth unemployment and long-term unemployment). Among the different labor market flexibility indicators analyzed, hiring and firing regulations and hiring costs are found to have the strongest effect.
March 1, 2012
Operative Principles of Islamic Derivatives: Towards a Coherent Theory
Description: Derivatives are few and far between in countries where the compatibility of financial transactions with Islamic law requires the development of shari'ah-compliant structures. Islamic finance is governed by the shari'ah, which bans speculation and gambling, and stipulates that income must be derived as profits from the shared generation of goods and services between counterparties rather than interest or a guaranteed return. The paper explains the fundamental legal principles underpinning Islamic finance with a view towards developing a cohesive theory of derivatives subject to shari'ahprinciples. After critically reviewing accepted contracts and the scholastic debate surrounding existing financial innovation in this area, the paper offers an axiomatic perspective on a principle-based permissibility of derivatives under Islamic law.