The Political Economy of Underdevelopment

1. The Political Economy of Underdevelopment Bernardo Mueller Department of Economics University of Brasilia - Brazil

2. In a Coasean world there would be no underdevelopment.

3. Motivation • Is growth an exogenous inexorable process? … Are poor economies incipiently catching up in regular ways with those already richer? (Danny Qua, 1996, European Economic Review) • Will relatively poor economies remain poor for many generations? Will the rich countries of the year 2100 be the same countries that are relatively rich today? (Sala-i-Martin, 1996, Economic Journal)

4. Convergence hypothesis • Forces pushing for convergence: • Diminishing returns to capital. • Poorer countries have higher rates of return leading capital to flow from richer countries. • Second mover advantages.

5. USA Australia Great Britain Netherlands France Sweden Germany Japan Argentina South Africa Mexico Brazil Botswana Egypt Indonesia Zimbabwe Bangladesh Source: Penn World Tables.

6.  - convergence X.X. Sala-i-Martin 1996. The Economic Journal.

7.  - convergence Robert J. Barro. 2000. “Rule of Law, Democracy and Economic Performance”in Heritage Foundation, 2000 Index of Economic Freedom.

8. Conditional  - convergence Barro. 2001. AEA Papers and Proceedings.

9. “...the speed of convergence has been estimated to be within a narrow range centering on 2 % per year (p=0.02). Although this is a very robust and strongly significant finding, I would like to emphasize that a speed of 2 % per year is very small. For example, it suggests that it will take 35 years for half of the distance between the initial level of income and the steady state level to vanish. This is quite slow.” Sala-i-Martin. 1996.The Economic Journal, Vol. 106, No. 437. (Jul.), pp.1034.

10. Corruption, Bureaucratic Efficiency, Political Instability • Paolo Mauro. 2005. • “Corruption and Growth” • The Quarterly Journal of • Economics, Vol. 110, • No. 3. (Aug., 1995), • pp. 681-712.

11. Economic Freedom Haan and Strum. 2007. “Handling Economic Freedom in Growth Regressions” Economic Journal Watch, Vol. 4 No. 1, January:79-82.

12. Religion Barro and McCleary, 2003. Religion and Economic Growth Across Countries. American Sociological Review, Volume 68, Number 5, 1 October 2003, pp. 760 -781(22) .

13. Democracy Feng, Y. 1997. Democracy, Political Stability and Economic Growth British Journal of Political Science, Vol. 27, No. 3. (Jul., 1997), pp. 391-418

14. Democracy Helliwell, J.F. 1994. Empirical Linkages between Democracy and Economic Growth British Journal of Political Science, Vol. 24, No. 2. (Apr., 1994), pp. 225-248

15. Social Trust Bjørnskov, C. 2007. “Social Capital and Economic Growth: A Survey” The Troika of Social Capital (eds. Gunnar L.H. Svendsen and Gert T. Svendsen)

16. Social Capital Stephen Knack; Philip Keefer. 1997. Does Social Capital Have an Economic Payoff? A Cross-Country Investigation The Quarterly Journal of Economics, Vol. 112, No. 4. (Nov., 1997), pp. 1251-1288

17. Ethnic Diversity Alesina, Alberto F. and La Ferrara, Eliana, "Ethnic Diversity and Economic Performance" (December 2003). Harvard Institute of Economic Research Discussion Paper No. 2028.

18. Legal Origin Levine, R. 1998. The Legal Environment, Banks, and Long-Run Economic Growth Journal of Money, Credit and Banking, Vol. 30, No. 3, Part 2: Comparative Financial Systems. (Aug., 1998), pp. 596-613.

19. Foreign Aid Rajan, R.G. and A.Subramanian. 2005 Aid and Growth: What Does the Cross-Country Evidence Really Show? IMF Working Paper, June.

20. Governance Olson JR. Sarna & Swamy, 2000. Governance and growth: A simple hypothesis explaining cross-country differences in productivity growth. Public Choice 102: 341–364.

21. Governance Stephen KnacK, 2006. Governance and Growth, October 2006

22. What has been learnt and what remains to be explored?

23. “… the results leave unexplained a good deal of the relatively weak growth performance of countries in sub-Saharan Africa and Latin America. That is, the analysis does not fully capture the characteristics of the typical country on these continents that lead to below-average growth.” Barro, Robert J, 1991. "Economic Growth in a Cross Section of Countries,” The Quarterly Journal of Economics, MIT Press, vol. 106(2), pages 407-43, May

24. Robert J. Barro. 1997. Determinants of Economic Growth: A Cross-Country Empirical Study, MIT Press, Cambridge .

25. Approaches to Understand the Political Economy of Underdevelopment • Stein, Tommasi, Echebarría, Lora and Payne.2006. The Politics of Policies: Economic and Social Progress in Latin America, Inter-American Development Bank. • Bueno de Mesquita, Smith, Siverson and Morrow. 2003. The Logic of Political Survival MIT Press. • Rajan, 2006. The Persistence of Underdevelopment: Constituencies and Competitive Rent Preservation, ECGI Working Paper.

26. Oliver Williamson. 2000. “The New Institutional Economics: Taking Stock, Looking Ahead” Journal of Economic Literature.

27. Transaction Cost Politics • Extension of Transaction Cost Economics to Politics and Policymaking. • Transaction costs are characteristically more pervasive in political processes than in economic interactions. • North. 1990. “A Transaction Cost Theory of Politics” Journal of Theoretical Politics, Oct 1990; 2: 355 - 367. • Dixit, A.K., 1996, The Making of Economic Policy: A Transaction-Cost Politics Perspective, Cambridge, Mass.: MIT Press

28. (game of) Policymaking process The Politics of Policies (2006). IADB. Characteristics of policy outcomes Basic Institutions and History Working of political institutions Characteristics of the issue area

29. (game of) Policymaking process The Politics of Policies (2006). IADB. Characteristics of policy outcomes Basic Institutions and History Working of political institutions Stability vs. volatility Adaptability vs. rigidity Public-regardedness vs. private regardedness Investment-like qualities Quality of implementation and enforcement Characteristics of the issue area

30. (game of) Policymaking process The Politics of Policies (2006). IADB. Characteristics of policy outcomes Basic Institutions and History Working of political institutions Stability vs. volatility Adaptability vs. rigidity Public-regardedness vs. private regardedness Investment-like qualities Quality of implementation and enforcement actors preferences powers sequence arenas forums frequency of interaction Characteristics of the issue area

31. (game of) Policymaking process The Politics of Policies (2006). IADB. Characteristics of policy outcomes Basic Institutions and History Working of political institutions Stability vs. volatility Adaptability vs. rigidity Public-regardedness vs. private regardedness Investment-like qualities Quality of implementation and enforcement actors preferences powers sequence arenas forums frequency of interaction Characteristics of the issue area All policy areas simultaneously (same country)

32. (game of) Policymaking process The Politics of Policies (2006). IADB. Characteristics of policy outcomes Basic Institutions and History Working of political institutions Stability vs. volatility Adaptability vs. rigidity Public-regardedness vs. private regardedness Investment-like qualities Quality of implementation and enforcement actors preferences powers sequence arenas forums frequency of interaction Characteristics of the issue area Budgetary process

33. (game of) Policymaking process The Politics of Policies (2006). IADB. Characteristics of policy outcomes Basic Institutions and History Working of political institutions Stability vs. volatility Adaptability vs. rigidity Public-regardedness vs. private regardedness Investment-like qualities Quality of implementation and enforcement actors preferences powers sequence arenas forums frequency of interaction Characteristics of the issue area Telecommunication sector (Levy and Spiller, 1996)

34. (game of) Policymaking process The Politics of Policies (2006). IADB. Characteristics of policy outcomes Basic Institutions and History Working of political institutions Stability vs. volatility Adaptability vs. rigidity Public-regardedness vs. private regardedness Investment-like qualities Quality of implementation and enforcement actors preferences powers sequence arenas forums frequency of interaction Characteristics of the issue area Environmental policy

35. Political Institutions in Brazil • Executive Preponderance • What are the President’s powers? • Sets the agenda in Congress. • Line item veto. • Decree power. • Cabinet and 40,000 federal jobs. • Discretion over appropriation of budget amendments. • Upshot: high governability at low cost.

36. Political Institutions in Brazil • Executive Preponderance • What are the President’s preferences? • Monetary stability. • Economic growth. • National macroeconomic variables.

37. Political Institutions in Brazil • Executive Preponderance • Why these preferences? • Electorate and inflationary memory. • Globalized financial markets.

38. Political Institutions in Brazil • Congress • Weak parties in the electoral arena, strong parties in the legislative arena. • Preferences for geographic redistribution. • Result: exchange of pork for policies leading to high levels of governability while still providing checks.

39. Political Institutions in Brazil • Other political actors and veto points • Judiciary (independent but slow). • Public prosecutors (independent, powerful and active) • Governors (no longer powerful at federal level) • Constitution (highly amended) • Bureaucracy (stable, high quality for Latin America)

40. Four categories of policies • Stable and adaptable macroeconomic policies.

41. Primary Surplus - Brazil Source: Banco Central do Brasil, Boletim de Finanças Públicas.

42. Four categories of policies • Stable and adaptable macroeconomic policies. • Exchange of pork for policies. (Alston and Mueller. 2006. JLEO).

44. Four categories of policies • Stable and adaptable macroeconomic policies. • Exchange of pork for policies. (Alston and Mueller. 2006. JLEO). • Hard-wired policies (Earmarked revenue and expenditures).

45. Evolution of Budgetary Earmarking, 1979-2003. Source: Brasil. Secretaria de Orçamento Federal. (2003) "Vinculações de Receita dos Orçamentos Fiscal e da Seguridade social e o Poder Discricionário de Alocação de Recursos do Governo Federal“ - Volume 1, N.1, Brasília, SOF, pg. 6. This graph does not include revenues from government bonds or privatization.

46. Four categories of policies • Stable and adaptable macroeconomic policies. • Exchange of pork for policies. (Alston and Mueller. 2006. JLEO). • Hard-wired policies (Earmarked revenue and expenditures). • Residual policies – contingent on the fiscal imperative and subject to political shocks.

47. “Impoundments” in Regulatory Agency Budget Source: Pereira Filho (2006).

48. Upshot • High levels of governability. • Stability, fiscal discipline, gradual reform. • Persistent institutional strengthening. • Gradually translating into higher levels of sustained growth.

49. Other Latin American Countries • Argentina • Venezuela • Bolivia • Chile • Ecuador • Mexico

50. Robert J. Barro. 2000. “Rule of Law, Democracy and Economic Performance”in Heritage Foundation 2000 Index of Economic Freedom.