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Research Roundup (2008-2011): Macroeconomics and Growth

Research on macroeconomics and growth focuses on understanding the diversity of aggregate economic performance across the world, and how it responds to policy and institutional changes under different country circumstances, in order to design policies and reform strategies conducive to sustained high growth, the essential ingredient of lasting poverty reduction.


Research on economic growth investigates how micro- and macroeconomic policy actions and reforms translate into lasting growth, with attention to the role of country-specific initial conditions and policy complementarities.

Research on macroeconomic risk management seeks to understand the sources of macroeconomic instability and the mechanisms of its propagation across countries, as well as the consequences for growth and welfare. The research focuses on identifying policy strategies to deal with aggregate risk. Of particular interest are the lessons from the global crisis for managing risk under deepening international integration.

Research on governance and political economy examines the consequences of weak governance for government performance, macroeconomic stability and growth, and identifies institutional reforms and incentives that contribute to improving governance.


After the global crisis: new questions on macro-financial policies and propagation mechanisms

The global crisis has prompted a reassessment of the macroeconomic and development policies adopted in recent years by many developing economies. The macroeconomic dimensions of financial fragility, ignored by traditional micro-prudential regulation, call for the design of an adequate macro-prudential regime to deter boom-bust cycles of credit and asset prices. Macroeconomic policies need to assist in this task by adopting a more countercyclical stance. In particular, pending the development of suitable macro-prudential tools, monetary policy may face a challenging balance between its primary objective of price stability and the need to safeguard financial stability.[1,2]
Financial imbalances are typically built up in the upswing, largely because economic bonanzas tend to exacerbate financial market imperfections. Financial systems have limited ability to screen good projects from bad ones, and favorable aggregate shocks encourage entry of high-risk but low-productivity projects. This limits the beneficial effects of such shocks and amplifies their contribution to aggregate financial fragility.[3]  The adverse consequences materialize in bad times, in which small macroeconomic shocks can quickly cause big financial turmoil. Evidence from bank runs in Argentina and Uruguay in the 2000s shows that macroeconomic risk affects deposits quite aside from the bank-specific risk characteristics underscored by conventional analyses. Differences in bank exposure to macroeconomic factors can explain differences in deposit withdrawals across banks, especially during turbulent times.[4]

The crisis has called attention to the mechanisms underlying the amplification and international propagation of financial turbulence, which have been strengthened by global integration. Indeed, close inspection of trade and financial data reveals that the main channels of contagion across countries—international trade linkages, and financial linkages through the cross-border asset holdings of international investors— are stronger today than in the 1990s, thus enlarging the potential for rapid propagation of shocks.[5,6]

Trade credit represents a potentially important—but often neglected—propagation channel, as a growing number of nonfinancial firms simultaneously receive credit from their suppliers and grant it to their customers. International evidence reveals that increased use of this kind of credit along a supply chain linking different industries significantly increases the correlation between their outputs, which shows that trade credit propagates shocks across industries.[7

Banks’ reliance on wholesale funding provided a major propagation mechanism during the global crisis. Wholesale markets dried up, as lenders staged what in effect amounted to a run on banks. An assessment of the impact of the liquidity crunch that followed the demise of Lehman Brothers uncovers a large return differential, both globally and within countries, between the stocks of banks more reliant on nondeposit sources of funds and those less dependent on such funding.[8] This echoes the long-held view that short-term borrowing represents a source of vulnerability to financial shocks, and begs the question of why developing countries borrow short term. The simple answer, based on detailed data on sovereign bond prices and issuances at different maturities, is that it is cheaper than borrowing long term. Countries typically pay a higher risk premium on longer-term bonds, especially in times of crisis. This can be viewed as the outcome of a risk-sharing problem between an emerging economy subject to rollover crises, and risk-averse international investors.[9]

Mutual funds have become increasingly important players in global financial markets, and evidence shows that they engaged in large portfolio reallocations during the global crisis. Their behavior tends to be pro-cyclical, reducing their exposure to countries during bad times and increasing it when conditions improve. Hence capital flows from mutual funds do not seem to play a stabilizing role, but rather expose the countries in their portfolios to foreign shocks.[10
Temporary capital controls might help shelter countries from external financial shocks accruing through these channels, but evidence on their effectiveness has remained elusive. Yet the fact that major emerging-market stocks now trade in both domestic and international markets this allows a direct assessment of the effects of capital controls. In their absence, price deviations across markets are rapidly arbitraged away, particularly for liquid stocks. But barriers to cross-border capital flows effectively segment markets: controls on capital outflows induce positive premia between domestic and foreign markets, while controls on inflows have the opposite effect. The size of these premia varies with the intensity of capital controls.[11]

The effect of the global crisis on different countries entails lessons for macroeconomic risk management.[12] Contrary to popular perception, emerging-market economies suffered growth collapses comparable to, or even larger than, those of advanced economies in 2008–09. But the former recovered faster than the latter and resumed growth at a faster rate post-crisis. Moreover, the policy response of emerging economies represented a sharp departure from the past: this time they implemented countercyclical macro-financial policies and managed to cushion the impact of the crisis. This was facilitated by more prudent fiscal and monetary policies prior to the crisis, as well as by the increased exchange rate flexibility that many countries allowed in response to shocks.[13,14

Macroeconomic crises often leave countries saddled with a “debt overhang” that makes them vulnerable to financial shocks and deters growth. In recent years, this has prompted debt relief measures for poor countries. But the economic benefits of debt relief have been difficult to sort out, partly because expected economic performance drives the decision to grant relief. An event study of the response of the stock prices of South African multinationals with subsidiaries in recipient countries to the announcement of debt relief initiatives helps resolve these “reverse causality” problems. The stock prices of these companies exhibit a significant increase above those of other firms, suggesting that financial markets view debt relief as beneficial for firms operating in recipient countries. This is consistent with an expected improvement in economic conditions, as implied by the “debt overhang” argument for debt relief.[15]

In many countries, expansionary fiscal policy played a central role in the response to the global crisis. But there is little solid evidence on the magnitude of its effects, because identifying them requires a strategy for finding changes in government spending that are themselves not driven by current macroeconomic shocks. In aid-dependent, low-income countries, one way to do so is by exploiting the long lags between approval and full disbursement of World Bank–financed projects. Nearly all of World Bank–financed government spending in a given year reflects project approval decisions made in previous years, and so does not react to current macroeconomic shocks. Using this strategy, the impact of an additional dollar of government spending on output is estimated to be zero, which suggests the need for considerable skepticism regarding the effectiveness of short-run, spending-based fiscal stimulus packages in poor countries.[16]

Microeconomic regulation is a major determinant of macroeconomic performance

There is broad agreement that productivity improvements account for the bulk of long-run income growth. Much less is known—notably in developing countries—about how firm-level productivity contributes to aggregate efficiency and growth. A key mechanism seems to be the Schumpeterian “creative destruction” process that transfers resources from low- to high-productivity industries and firms, but its role in emerging economies has remained relatively unexplored. New research examines the regulatory framework faced by firms in developing countries and the implications for firm renewal and macroeconomic performance.[17]
Excessive or inadequate microeconomic regulation of goods and factor markets limits the reallocation of resources and distorts both the relative profitability of different activities and the incentives to innovation, which is a key driver of growth.[18,19] By limiting the economy’s ability to redeploy resources in the face of shocks, this leads to higher aggregate volatility as well. Moreover, the adverse effects of excessive regulation on growth and stability are particularly large under poor-governance conditions. Thus, streamlining the regulatory framework is likely to bring significant social payoffs especially in developing countries burdened by weak governance.

In turn, evidence from Indonesia shows that deep crises unambiguously weaken the reallocation process. The East Asian crisis attenuated the relationship between productivity and survival, causing the exit of relatively productive firms. On the bright side, firms that entered during the crisis were relatively more productive, which helped mitigate the fall in aggregate productivity.[20]

The growth payoff of reforms depends on complementary measures and initial conditions

A considerable literature has examined the merits of reform packages vis-à-vis specific reforms. International evidence for the case of trade liberalization shows that the former option is likely to deliver a bigger growth impact. The reason is that the ability of reforming countries to take advantage of increased international competition and access to foreign markets depends on complementary reforms and structural factors that shape the availability of productive inputs—such as human capital and infrastructure services—and the efficiency with which they can be reallocated to their most productive uses following trade reform, as determined by labor market flexibility, financial market development, overall governance quality, and ease of firm entry and exit. The growth payoff from trade reform is bigger when the removal of obstacles to trade is accompanied by complementary domestic reforms in these areas.[21] Related research shows that, given the set of accompanying measures, trade reform has a bigger growth impact when prior to reform trade is severely distorted—namely, the marginal benefit declines with the extent of reform.[22]

The effect of disasters on growth depends on the type of disaster and the stage of economic development

Despite the tremendous human suffering caused by natural disasters, previous research has not reached clear conclusions regarding their effects on economic growth. Closer analysis distinguishing among disaster types and economic sectors yields three major insights. First, the effect of disasters on economic growth is not always negative—droughts, for instance, tend to reduce agricultural growth, while floods have a positive effect on overall growth. Second, although moderate disasters can have a positive growth effect in some sectors, severe disasters do not. Third, growth in developing countries is more sensitive to natural disasters than in developed ones, with more sectors affected and the effects larger and economically meaningful.[23]

Policy can have a significant impact on the mortality caused by disasters. In the case of earthquakes, governments can enforce quakeproof construction regulation, but many do not. In poor countries in which earthquakes are rare, households and governments are reluctant to divert resources from pressing immediate needs to costly measures to prevent earthquake mortality. But even in places where earthquakes are more common, the government response also depends on incomes and political incentives of governments to provide public goods. Governments with fewer political incentives to provide public goods respond less to an increase in earthquake propensity. This means that post-earthquake relief must remain a high priority for donors.[24]

Collective action by informed citizens and good governance may be mutually reinforcing

There is broad consensus that good governance contributes to improved growth and development outcomes, and collection and update of suitable measures of governance remains a research priority. [25,26]  However, less is known about how to achieve good governance. Citizens’ ability to enforce policy makers’ accountability is viewed by many as a key to improve governance. Political parties can play an important role in this regard, by allowing citizens to take collective action to sanction political actors that renege on their commitments. Across countries, there is a robust positive relation between development outcomes and the degree to which political parties facilitate collective action. This underscores the need for greater attention to the organizational characteristics of countries that allow citizens to hold leaders accountable.[27

A similar mechanism is partly responsible for the fact that democratizing countries typically display worse fiscal outcomes—lower public investment and greater corruption—than established democracies. The difference is due to the low credibility of electoral promises in new democracies, which leads to higher targeted transfers and corruption and lower public good provision.[28] In turn, research using data from India suggests that citizen information can facilitate collective action and thereby help improve governance. India’s constituency development funds allow individual legislators to finance local public infrastructure in their electoral districts. The data show that politicians spend less of their fund entitlement when media coverage of the program is low.[29]

Unaccountable institutions may themselves undermine collective action by citizens. Research using data from the Gallup World Poll documents a quantitatively large and statistically significant negative correlation between corruption and confidence in public institutions. The correlation is robust to the inclusion of a large set of controls for country and respondent-level characteristics, so it reflects at least in part a causal effect of corruption on confidence. Individuals with low confidence in institutions exhibit low levels of political participation, show increased tolerance for violent means to achieve political ends, and have a greater desire to “vote with their feet” through emigration.[30]  Overall, this suggests that corruption can inhibit development by eroding confidence in public institutions.

Individuals’ inability to cooperate with one another, and to enforce social norms that restrain opportunistic behavior, can deter development by weakening government accountability, property rights, and contract enforcement. Results from experiments conducted in India to study coordination and to measure social preferences reveal that a large majority of subjects exhibit “spiteful preferences”: they punish cooperative behavior, even though such punishment increases inequality, decreases the payoffs of all participants, and weakens the deterrent effect of punishment of norm violations. Further, the willingness to reduce another’s material payoff—either for the sake of achieving more equality or for the sake of being ahead—is stronger among individuals belonging to high castes than among those belonging to low castes.[31]  Related experiments show that individuals at the bottom of the caste hierarchy also exhibit a much lower willingness than the rest to punish norm violations that hurt members of their own caste,[32]  which may hamper their prospects for overcoming poverty and likely reflects the effect on their social preferences of a long-standing legacy of inequality and social exclusion.[33]  


Luis Servén, Senior Advisor, Development Research Group, Development Economics Vice Presidency, World Bank, Washington, DC (



1. Demirgüç-Kunt, Asli, and Luis Servén. 2010. “Are All the Sacred Cows Dead? Implications of the Financial Crisis for Macro- and Financial Policies.” World Bank Research Observer 25(1): 91–124.

2. de la Torre, Augusto, Alain Ize, and Sergio L. Schmukler. 2011. Financial Development in Latin America and the Caribbean: The Road Ahead. Washington, DC: World Bank. Download

3. Hoff, Karla. 2010. “Dysfunctional Finance: Positive Shocks and Negative Outcomes.” Journal of Globalization and Development 1(1): Article 4, January.

4. Levy-Yeyati, Eduardo, María Soledad Martínez Pería, and Sergio L. Schmukler. 2010. “Depositor Behavior under Macroeconomic Risk: Evidence from Bank Runs in Emerging Economies.” Journal of Money, Credit, and Banking 42(4): 585–614.

5. Schmukler, Sergio L., Tatiana Didier, and Paolo Mauro. 2008. “Vanishing Contagion?” Journal of Policy Modeling 30(5): 775–91.

6. Aizenman, Joshua, and Brian Pinto. Forthcoming. “Managing Financial Integration and Capital Mobility: Policy Lessons from the Past Two Decades.” Review of International Economics. (Based on Policy Research Working Paper 5786, World Bank, Washington, DC.)

7. Raddatz, Claudio E. 2010. “Credit Chains and Sectoral Comovement: Does the Use of Trade Credit Amplify Sectoral Shocks?” Review of Economics and Statistics 92(4): 985–1003.

8. Raddatz, Claudio E. 2010. “When the Rivers Run Dry: Liquidity and the Use of Wholesale Funds in the Transmission of the US Subprime Crisis.” Policy Research Working Paper 5203, World Bank, Washington, DC.

9.  Broner, Fernando, Guido Lorenzoni, and Sergio L. Schmukler. Forthcoming. “Why Do Emerging Economies Borrow Short Term?” Journal of the European Economic Association. (Based on Policy Research Working Paper 3389, World Bank, Washington, DC.)

10.  Raddatz, Claudio E., and Sergio L. Schmukler. Forthcoming. “On the International Transmission of Shocks: Micro-Evidence from Mutual Fund Portfolios.” Journal of International Economics. (Based on NBER Working Paper 17358, Cambridge, Mass.)

11. Levy-Yeyati, Eduardo, Sergio L. Schmukler, and Neeltje Van Horen. 2009. “International Financial Integration through the Law of One Price: The Role of Liquidity and Capital Controls.” Journal of Financial Intermediation 18: 432–63.

12. Ghosh, Swati, Naotaka Sugawara, and Juan Zalduendo. 2011. “Finding a Balance Between Growth and Vulnerability Trade-offs.” Policy Research Working Paper 5592, World Bank, Washington, DC.

13. Didier, Tatiana, Constantino Hevia, and Sergio L. Schmukler. 2011. “How Resilient Were Emerging Economies to the Global Crisis?” Policy Research Working Paper 5637, World Bank, Washington, DC.

14. Schmukler, Sergio L., Tatiana Didier, and Constantino Hevia. 2011. “Emerging Country Responses to the Global Crisis.” In Financial Contagion: The Viral Threat to the Wealth of Nations, ed. Robert W. Kolb. New York: Wiley.

15.  Raddatz, Claudio E. 2011. “Multilateral Debt Relief through the Eyes of Financial Markets.” Review of Economics and Statistics 93: 1262–88.

16.  Kraay, Aart C. Forthcoming. “How Large is the Government Spending Multiplier? Evidence from World Bank Lending.” Quarterly Journal of Economics. (Based on Policy Research Working Paper 5500, World Bank, Washington, DC.)

17. Loayza, Norman V., and Luis Servén. 2010. Business Regulation and Economic Performance. Washington, DC: World Bank. Download

18. Bergoeing, Raphael, Norman V. Loayza, and Facundo Piguillem. 2010. “Why Are Developing Countries So Slow in Adopting New Technologies? The Aggregate and Complementary Impact of Micro Distortions.” Policy Research Working Paper 5393, World Bank, Washington, DC.

19. Brahmbhatt, Milan, and Albert Hu. 2010. “Ideas and Innovation in East Asia.” World Bank Research Observer 25(2): 177–207.

20. Hallward-Driemeier, Mary, and Bob Rijkers. 2011. “Do Crises Catalyze Creative Destruction? Firm-level Evidence from Indonesia.” Policy Research Working Paper 5869, World Bank, Washington, DC.

21. Chang, Roberto, Linda Kaltani, and Norman V. Loayza. 2009. “Openness Can Be Good for Growth: The Role of Policy Complementarities.” Journal of Development Economics 90(1): 33–49.

22. Loayza, Norman V., and Linda Kaltani. 2008. “Initial Conditions and the Outcome of Economic Reform.” Economics Letters 101(3): 230–33.

23. Loayza, Norman V., Eduardo Olaberría, Jamele Rigolini, and Luc Christiaensen. Forthcoming. “Natural Disasters and Growth: Going beyond the Averages.” Journal of Applied Econometrics. (Based on Policy Research Working Paper 4980, World Bank, Washington, DC.)

24. Keefer, Philip E., Eric Neumayer, and Thomas Pluemper. 2011. “Earthquake Propensity and the Politics of Mortality Prevention.” World Development 39 (9): 1530–41.

25. Kraay, Aart, and Dani Kaufmann. 2008. “Governance Indicators: Where Are We, and Where Should We Be Going?” World Bank Research Observer 23(Spring): 1–30.

26. A major output from this work is the widely used Worldwide Governance Indicators dataset covering more than 200 countries since 1996, available at

27. Keefer, Philip E. 2011. “Collective Action, Political Parties and Pro-Development Public Policy.” Asian Development Review 28: 94–118.

28. Keefer, Philip E., and Razvan Vlaicu. 2008. “Democracy, Credibility and Clientelism.” Journal of Law, Economics and Organization 24(2): 371–406.

29. Keefer, Philip E., and Stuti Khemani. 2009. “When Do Legislators Pass on Pork? The Role of Political Parties in Determining Legislator Effort.” American Political Science Review 103(1): 99–112. 

30. Clausen, Bianca, Aart Kraay, and Zsolt Nyiri. 2011. “Corruption and Confidence in Public Institutions: Evidence from a Global Survey.” World Bank Economic Review 25: 212–49.

31. Fehr, Ernst, Karla Hoff, and Mayuresh Kshetramade. 2008. “Spite and Development.” American Economic Review, Papers & Proceedings 98(2): 494–99.

32. Fehr, Ernst, Karla Hoff, and Mayuresh Kshetramade. 2011. “Caste and Punishment—The Legacy of Caste Culture in Norm Enforcement.” Economic Journal 121(566): F449–75.

33. Fehr, Ernst, and Karla Hoff. 2011. “Tastes, Castes, and Culture: The Influence of Society on Preferences.” Economic Journal 121(556): F396–412.

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