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Research Highlights 2007: Macroeconomics and Growth

Themes
Highlights
The development payoffs from public investment are weakened by poor governance
Financial markets in emerging economies do not grind to a halt during crises—trading actually rises, but trading costs are also sharply higher
Fast-growing and rapidly diversifying economies emerging from conflict are far more likely to succeed at building lasting peace
Political and economic development can help avert terrorism
Team
Notes

Growth is essential for sustained poverty reduction, the Bank’s paramount objective. Sustained rapid growth is needed to achieve the other Millennium Development Goals and speed up development. The research program on macroeconomics and growth aims to guide policies and reform strategies conducive to sustained high growth. To do this, research seeks to identify the factors behind the diversity in aggregate economic performance across the world and understand how it is affected by policy and institutional changes under different country circumstances.

Themes

The research program explores the micro- and macroeconomic foundations of growth and aggregate economic performance. It has an empirical orientation and draws from a wide range of data sources—from firm surveys to national macroeconomic data, as well as simulation models. Current research on growth seeks to understand how policy actions and reforms translate into growth, with special attention to the role of country-specific initial conditions and complementarities among different policies.

Ongoing work explores firm dynamics and microeconomic efficiency and how they contribute to aggregate performance, as well as the effects of the policy and institutional environment on innovation and technological upgrading. Work on the growth effects of macroeconomic policies investigates the consequences of fiscal targets and public spending for long-term growth.

Research on macroeconomic instability examines the contribution of policy and other forces (such as external shocks and other exogenous disturbances) to aggregate volatility. It assesses reforms to reduce the frequency and impact of disturbances through suitable macroeconomic policies, as well as policy measures to tackle microeconomic inflexibility.[15]

The opportunities and risks posed by international economic integration are also a major research theme. Access to external financing broadens firms’ and countries’ investment and risk diversification possibilities but may also increase macroeconomic vulnerabilities. Research explores the trade-offs among these effects under different policy and institutional conditions.

Research on the role of governance and institutions for sustained growth draws on both aggregate and firm data to assess the effects of governance, determine the channels through which it affects economic efficiency and aggregate growth, and identify the institutional and political economy factors, such as citizen information and political accountability, that contribute to good
governance. Ongoing work on conflict and violence assesses the policy and institutional strategies conducive to sustained peace in countries emerging from conflict.[16]



Highlights

The development payoffs from public investment are weakened by poor governance


The adverse influence of weak governance on private investment is a well-known deterrent to development. Less well-understood is the effect of insecure property rights on government policy choices. Research shows that public investment is robustly higher in countries with low-quality governance and limited political checks and balances. Moreover, higher public investment in such countries does not yield higher-quality public infrastructure, which one would expect if public investment were meant to promote growth.

Instead, the most plausible explanation for the association of high public investment and weak governance is that governments use their investment as a vehicle to fuel rent-seeking. Hence, efforts to increase public investment in countries with weak governance, or to measure the growth contribution of the public sector using only observed measures of public investment, should be undertaken with considerable caution.[17]



Financial markets in emerging economies do not grind to a halt during crises—trading actually rises, but trading costs are also sharply higher

Firms’ and governments’ access to capital at low cost is key to investment and growth. Investors’ ability to liquidate their positions when crises arise—as they frequently do in emerging markets—is a major factor behind their willingness to provide financing. The popular view is that markets shut down in turbulent times, with sellers struggling to find buyers at fire-sale prices in the face of dwindling liquidity.

However, a thorough review of emerging market crisis episodes reveals that markets continue to operate during financial turmoil, even in narrow and volatile emerging economies. Both trading volume and trading costs increase during crisis times. Prices react more abruptly to transacted amounts and bid-ask spreads widen. More generally, large price downturns, typical of crises, are associated with higher, not lower, trading activity and increased trading costs. These higher trading costs at times of distress will be ultimately reflected in the risk-adjusted return demanded by investors, thus raising firms’ ex ante cost of capital.[18]



Fast-growing and rapidly diversifying economies emerging from conflict are far more likely to succeed at building lasting peace

Evidence from the immediate postconfllict period shows that UN peacekeeping operations are instrumental for maintaining peace,[19] and that high economic growth rates have allowed a recovery of critical education and health indicators.[20] Aid has been key, not only to finance physical infrastructure, but also to avert a high-inflation spiral in postconfllict economies, thus assisting with their financial reconstruction.[21] But these short-term gains may be difficult to sustain.

First, lasting peace and growth need adequate institutions to deliver public goods, which in turn require stable national coalitions that transcend narrow ethnic or regional power bases, overcoming an entrenched culture of political fragmentation.[22] Second, high aid could lead to overvalued currencies at a time when sustained growth needs international competitiveness and economic diversification.[23] These political and economic imperatives need to be present in the design of UN peacekeeping operations and aid strategies in postconfllict transitions.[24]


 
Political and economic development can help avert terrorism

Governments’ rising concern with terrorism has put the spotlight on the potential links between terrorism and development. To what extent are they related? What are the roles of the economic, political, and social aspects of development? What is the development effect of different responses to terrorism?

Recent research addresses these crucial questions. It finds that political development—political openness and the quality of government—is inversely associated with the emergence of terrorist organizations. National economic development, mainly international openness can also forestall terrorism. Rich countries can help developing ones avoid the scourge of terrorism through a shift toward greater development emphasis—improving governance, promoting international integration, and raising opportunities—rather than a military response as counterterrorism policy evolves.[25]

Team 

Notes

 15. Loayza, Norman V., Guest ed. 2007. "Volatility and Growth: A Symposium." World Bank Economic Review 21(3).

 16. Elbadawi, Ibrahim, Guest ed. 2008. "A Symposium on Post-Conflict Transitions." World Bank Economic Review 22(1).

Elbadawi, Ibrahim, Håvard Hegre, and Gary Milante, Guest ed. Forthcoming. "A Symposium on the Politics of Post-Conflict Transitions." Journal of Peace Research.

 17. Keefer, Philip E., and Stephen Knack. 2007. "Boondoggles, Rent-seeking and Political Checks and Balances: Public Investment under Unaccountable Governments." Review of Economics and Statistics 89(2): 566–72.

 18. Levy-Yeyaty, Eduardo, Sergio Schmukler, and Neeltje Van Horen. Forthcoming. "Emerging Market Liquidity and Crises." Journal of the European Economic Association.

 19. Sambanis, Nicholas. 2008. "Short- and Long-term Effects of United Nations Peace Operations." World Bank Economic Review 22(1).

 20. Chen, Siyan, Norman V. Loayza, and Marta Reynal-Querol. 2008. "How Do Countries Perform in the Aftermath of Civil War?" World Bank Economic Review 22(1).

 21. Adam, Christopher, Paul Collier, and Victor Davies. 2008. "Postconflict Monetary Reconstruction." World Bank Economic Review 22(1).

 22. Keefer, Philip. 2008. "Insurgency and Credible Commitment in Autocracies and Democracies." World Bank Economic Review 22(1).

 23. Elbadawi, Ibrahim A., Linda Kaltani, and Klaus Schmidt-Hebbel. 2008. "Foreign Aid, the Real Exchange Rate, and Growth in the Aftermath of Civil Wars." World Bank Economic Review 22(1).

 24. Sambanis, Nicholas. 2008. "Short- and Long-Term Effects of United Nations Peace Operations." World Bank Economic Review 22(1).

Chen, Siyan, Norman V. Loayza, and Marta Reynal-Querol. 2008. "How Do Countries Perform in the Aftermath of Civil War?" World Bank Economic Review 22 (1).

Adam, Christopher, Paul Collier, and Victor Davies. 2008. "Postconflict Monetary Reconstruction." World Bank Economic Review 22(1).

Keefer, Philip.  2008. "Insurgency and Credible Commitment in Autocracies and Democracies." World Bank Economic Review 22(1).

Elbadawi, Ibrahim A., Linda Kaltani, and Klaus Schmidt-Hebbel. 2008. "Foreign Aid, the Real Exchange Rate, and Growth in the Aftermath of Civil Wars." World Bank Economic Review 22(1).

 25. Keefer, Philip E., and Norman V. Loayza. 2008. Terrorism, Political Openness, and Economic Development. New York: Cambridge University Press.




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