Institutions matter part 2

I'd like to go back to that article in the Economist I mentioned a few posts back. The article makes a good point which is of a different sort of perspective. Political constraints that interfere with economically efficient solutions is indeed another form of institutional constraints that interfere with efficient economic choices. The most common analyses of how institutions matter for economic growth is in cases where it limits the growth of certain economies: trade policies that inhibit the free flow of goods to and fro a country, labor market policies that constrain the growth of establishments, even the lack of reinforcing property rights. But the article points to one other aspect--that of preventing an economy from rebounding (efficiently) from an economic slowdown, or in this case, an economic crisis.

The same way that institutions should foster the economic growth of a country (breaking down trade barriers, a strong reinforcement of rule of law, etc.), institutions should also take the role of ensuring a country gets back to its growth track after experiencing a devastating crisis. One way is safety nets should have already been in place to mitigate the adverse effects on the already vulnerable members of the population (the poor and the marginalized), as we have espoused in our recent paper. Another one, which seems to be a revolutionary idea, is suggested by Raghuram Rajan, former IMF chief economist, in another Economist article: a cycle-proof regulation--a regulatory system that is immune to boom and bust. And like Dr. Rajan mentioned in his article, there should also be a balance so as not to over-regulate, but enough so that the policies in place would last for many years.

Online resource for economists

I've added two excellent online resources for economists on the nav bar on the left: the aptly named Resource for Economists maintained by the American Economics Association, and the list of Economic Journals on the Web maintained by the Department of Economics at State University of New York in Oswego.

Very, very useful sites.

All these financial talk... what about the poor?

The recent global economic is probably the worst that has happened in the Asian region since the 1997 financial crisis. The dust hasn't settle though: academic discussions are still abound--what went wrong, what will be the impact on other non-financial sectors, and what could be done to prevent the same crisis happening again. You can check the latest issue of the Economist to see that it's still a long way to go before that third type of discussion is going to be resolved. While it still remains to be seen what will happen to the other non-financial sectors, we economists can have an idea on what will happen based on certain assumptions. Of course, making assumptions is an essential part of an economist. But that's not the main point really.

For Asian countries, one of the important aspects is the poverty dimension. Much has already been done among Asian countries in reducing poverty. Since poverty reduction is essentially difficult to achieve without economic growth, this ongoing gloabl economic slowdown already being experienced by these Asian nations is going to be a cause for great concern. Needless to say, we can expect a slowdown or a complete stop in the reduction of poverty. Worst, the global economic slowdown may lead to more poverty. So how will the picture of Asian poverty take shape in the coming months or years?

Of course, we can come up with sophisticated models that would predict what would happen to poverty. These models may utilize the state of the art econometric methods or involve a gazillion dependent variables to consider--because the more variables you include, the more close it is to reality. But forget that for the moment. Just simply consider the relationship between the two variables, poverty and GDP per capita. Let's just consider one of the most basic analyis--how much change in the level of poverty will happen now that we expect GDP per capita to change? In other words, let's consider the impact of the global economic slowdown on poverty by making use of the elasticity of poverty due to a change in GDP per capita. This is exactly what Rana Hasan, Maria Rhoda Magsombol, and me did in the latest working paper from the Asian Development Bank.

We try to predict how the economic slowdown will affect the incidence of poverty in developing Asia over the next 2 years. We provide numbers on the basis of various scenarios for economic growth using the empirical relationship observed between poverty and incomes between 1990 and 2005. We used different scenarios because there is still considerable uncertainty regarding how much countries will grow in 2009 and 2010.

As mentioned in the previous paragraph, our starting point for projecting poverty incidence in 2009 and 2010 is the empirical relationship between economic growth and poverty reduction observed between 1990 and 2005. We estimate this relationshop using a simple linear regression model whereby the log of the poverty rate is regressed on GDP per capita. The resulting coefficient would then be our estimate of the growth elasticity of poverty. The regression is estimated separately for each Asian subregion in order to account for the fact that the relationship between economic growth and poverty reduction is likely to vary within a region as large and diverse as developing Asia.

Indeed, we do find that growth elasticities vary considerably across subregions. The growth elasticity in Central and West Asia is considerably higher than in other subregions, including Southeast Asia. Much lower growth elasticities are found in the Pacific and South Asia. Furthermore, the growth elasticity is smaller in absolute value for higher poverty lines, confirming previous research. But enough of that--what we want to know more is what will happen in the next two years.

So assuming that each subregional growth elasticity applies to every country within a subregion, we can estimate what poverty would be like in each country based on different scenarios for the growth of country-specific GDP per capita. Our estimates indicate that a reductionin growth of GDP per capita of between 1 to 3 percentage points over growth registered in 2007 would result in 21 to 61 million additional $1.25/day poor in 2009 and 34 to 98 million additional poor in 2010 as compared to a baseline scenario of no economic slowdown. Correspondingly, in terms of $2.00/day poverty, the picture is worst.

One cannot know now which is the most accurate scenario, but that may eventually be besides the point. It will be worst than the case where this whole global economic slowdown didn't happen at all. Needless to say, it will become crucial to get affected economies of the region back to paths of economic high growth and for them to provide mechanisms for protecting the welfare of the poor and vulnerable. Countries will need to consider how to alleviate adverse conditions for their populations, especially those subgroups that are already poor and whose plight is likely to worsen, and those liable to fall in poverty.