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Abstract:
This paper reports on the latest update of the Worldwide Governance Indicators (WGI) research project, covering 212 countries and territories and measuring six dimensions of governance between 1996 and 2006: Voice and Accountability, Political Stability and Absence of Violence, Government Effectiveness, Regulatory Quality, Rule of Law, and Control of Corruption. This latest set of aggregate indicators, are based on hundreds of specific and disaggregated individual variables measuring various dimensions of governance, taken from 33 data sources provided by 30 different organizations. The data reflect the views on governance of public sector, private sector and NGO experts, as well as thousands of citizen and firm survey respondents worldwide. We also explicitly report the margins of error accompanying each country estimate. These reflect the inherent difficulties in measuring governance using any kind of data. We find that even after taking margins of error into account, the WGI permit meaningful cross-country comparisons as well as monitoring progress over time. In less than a decade, a substantial number of countries exhibit statistically significant improvements in at least one dimension of governance, while other countries exhibit deterioration in some dimensions.

governance, indicators, voice, accountability, corruption, rule of law, government, margins of error, millennium challenge account, political stability, transparency

Abstract:
This paper reports on the latest update of the Worldwide Governance Indicators (WGI) research project, covering 212 countries and territories and measuring six dimensions of governance between 1996 and 2007: Voice and Accountability, Political Stability and Absence of Violence/Terrorism, Government Effectiveness, Regulatory Quality, Rule of Law, and Control of Corruption. The latest aggregate indicators are based on hundreds of specific and disaggregated individual variables measuring various dimensions of governance, taken from 35 data sources provided by 32 different organizations. The data reflect the views on governance of public sector, private sector and NGO experts, as well as thousands of citizen and firm survey respondents worldwide. We also explicitly report the margins of error accompanying each country estimate. These reflect the inherent difficulties in measuring governance using any kind of data. We also briefly describe the evolution of the WGI since its inception, and show that the margins of error on the aggregate governance indicators have declined over the years, even though they still remain non-trivial. We find that even after taking margins of error into account, the WGI permit meaningful cross-country comparisons as well as monitoring progress over time. In less than a decade, a substantial number of countries exhibit statistically significant improvements in at least one dimension of governance, while other countries exhibit deterioration in some dimensions.

Governance, corruption, rule of law, indicators, voice

Abstract:
Kaufmann, Kraay, and Mastruzzi present estimates of six dimensions of governance covering 199 countries and territories for four time periods: 1996, 1998, 2000, and 2002. These indicators are based on several hundred individual variables measuring perceptions of governance, drawn from 25 separate data sources constructed by 18 different organizations. The authors assign these individual measures of governance to categories capturing key dimensions of governance and use an unobserved components model to construct six aggregate governance indicators in each of the four periods. They present the point estimates of the dimensions of governance as well as the margins of errors for each country for the four periods. The governance indicators reported here are an update and expansion of previous research work on indicators initiated in 1998 (Kaufmann, Kraay, and Zoido-Lobaton 1999a, b and 2002). The authors also address various methodological issues, including the interpretation and use of the data given the estimated margins of errors.

This paper - a joint product of the Global Governance Department, World Bank Institute, and Macroeconomics and Growth, Development Research Group - is part of a larger effort in the Bank to generate and analyze worldwide governance indicators, and to assess the causes and consequences of governance.

Abstract:
Kaufmann, Kraay and Mastruzzi present the newly updated estimates of six dimensions of governance covering 209 countries and territories for five time periods: 1996, 1998, 2000, 2002 and 2004. These indicators are based on several hundred individual variables measuring perceptions of governance, drawn from 37 separate data sources constructed by 31 different organizations. The authors assign these individual measures of governance to categories capturing key dimensions of governance, and use an unobserved component model to construct six aggregate governance indicators in each of the four periods. They present the point estimates of the dimensions of governance as well as the margins of error for each country for the four periods. These margins of error are not unique to perceptions-based measures of governance, but are an important feature of all efforts to measure governance, including objective indicators. In fact, the authors provide examples of how individual objective measures provide an incomplete picture of even the quite particular dimensions of governance that they are intended to measure.

The paper also analyzes in some detail changes over time in our estimates of governance; provide a framework for assessing the statistical significance of changes in governance; and suggest a simple rule of thumb for identifying statistically significant changes in country governance over time. The ability to identify significant changes in governance over time is much higher for our aggregate indicators than for any individual indicator. While they find that the quality of governance in a number of countries has changed significantly (in both directions), the authors also provide evidence suggesting that there are no trends, for better or worse, in global averages of governance. Finally, the authors interpret the strong observed correlation between income and governance, and argue against recent efforts to apply a discount to governance performance in low income countries.

governance, indicators, voice, accountability, corruption, rule of law, government, margins of error, millennium challenge account, political stability, transparency

Abstract:
This paper reports on the 2009 update of the Worldwide Governance Indicators (WGI) research project, covering 212 countries and territories and measuring six dimensions of governance between 1996 and 2008: Voice and Accountability, Political Stability and Absence of Violence/Terrorism, Government Effectiveness, Regulatory Quality, Rule of Law, and Control of Corruption. These aggregate indicators are based on hundreds of specific and disaggregated individual variables measuring various dimensions of governance, taken from 35 data sources provided by 33 different organizations. The data reflect the views on governance of public sector, private sector and NGO experts, as well as thousands of citizen and firm survey respondents worldwide. We also explicitly report the margins of error accompanying each country estimate. These reflect the inherent difficulties in measuring governance using any kind of data. We find that even after taking margins of error into account, the WGI permit meaningful cross-country comparisons as well as monitoring progress over time.

Governance, corruption, rule of law, indicators, voice

Abstract:
Six new aggregate measures capturing various dimensions of governance provide new evidence of a strong causal relationship from better governance to better development outcomes.

In a cross-section of more than 150 countries, Kaufmann, Kraay, and Zoido-Lobaton provide new empirical evidence of a strong causal relationship from better governance to better development outcomes. They base their analysis on a new database containing more than 300 governance indicators compiled from a variety of sources. They provide a detailed description of each of these indicators and sources. Using an unobserved components methodology (described in the companion paper by Kaufmann, Kraay, and Zoido-Lobaton, Aggregating Governance Indicators, Policy Research Working Paper 2195), they then construct six aggregate indicators corresponding to six basic governance concepts: voice and accountability, political instability and violence, government effectiveness, regulatory burden, rule of law, and graft. As measured by these indicators, governance matters for development outcomes.

This paper - a joint product of Macroeconomics and Growth, Development Research Group; and Governance, Regulation, and Finance, World Bank Institute - is part of a larger effort in the Bank to study the causes and consequences of governance for development. The authors may be contacted at dkaufmann@worldbank.org, akraay@worldbank.org, or pzoidolobaton@worldbank.org.

Abstract:
The authors report on the latest version of the worldwide governance indicators, covering 213 countries and territories and measuring six dimensions of governance from 1996 until end-2005: voice and accountability, political stability and absence of violence, government effectiveness, regulatory quality, rule of law, and control of corruption. The latest indicators are based on hundreds of variables and reflect the views of thousands of citizen and firm survey respondents and experts worldwide. Although global averages of governance display no marked trends during 1996-2005, nearly one-third of countries exhibit significant changes [for better or for worse]on at least one dimension of governance. Three new features distinguish this update. (1) The authors have moved to annual reporting of governance estimates. This update includes new governance estimates for 2003 and 2005, as well as minor backward revisions to biannual historical data for 1996-2004. (2) The authors are, for the first time, publishing the individual measures of governance from virtually every data source underlying the aggregate governance indicators. The ready availability of the individual data sources underlying the aggregate governance indicators is aimed at further enhancing the transparency of the methodology and of the resulting aggregate indicators, as well as helping data users and policymakers identify specific governance challenges in individual countries. (3) The authors present new evidence on the reliability of expert assessments of governance which, alongside survey responses, form part of the aggregate measures of governance.

Governance Indicators, National Governance, Economic Policy, Institutions and Governance, Statistical&Mathematical Sciences, Scientific Research & Science Parks

Abstract:
Updated governance indicators report estimates of six dimensions of governance for 175 countries in 2000-01. They can be compared with those constructed for 1997-98.

Kaufmann, Kraay, and Zoido-Lobaton construct aggregate governance indicators for six dimensions of governance, covering 175 countries in 2000-01. They apply the methodology developed in Kaufmann, Kraay, and Zoido-Lobaton ("Aggregating Governance Indicators," Policy Research Working Paper 2195, and "Governance Matters," Policy Research Working Paper 2196, October 1999) to newly available data to arrive at governance indicators comparable with those constructed for 1997-98. The data is presented in the appendix, and accessible through an interactive Web-interface at http://www.worldbank.org/wbi/governance/govdata2001.htm.

This paper - a joint product of the Development Research Group and the Governance, Regulation, and Finance Division, World Bank Institute - is part of a larger effort in the Bank to develop and analyze governance research indicators and trends worldwide. For access to the data and related papers, visit http://www.worldbank.org/wbi/governance/pubs/govmatters2001.htm.

The authors may be contacted at dkaufmann@worldbank.org or akraay@worldbank.org.

Abstract:
It is well known that there is a strong positive correlation between per capita incomes and the quality of governance across countries. Kaufmann and Kraay propose an empirical strategy that allows separation of this correlation into (1) a strong positive causal effect running from better governance to higher per capita incomes, and, perhaps surprisingly at first, (2) a weak and even negative causal effect running in the opposite direction from per capita incomes to governance.

The first result confirms existing evidence on the importance of good governance for economic development. The second result is new and suggests the absence of a "virtuous circle" in which higher incomes lead to further improvements in governance. This motivates the authors' choice of title, "Growth Without Governance." They document this evidence using a newly updated set of worldwide governance-indicators covering 175 countries for the period 2000-01, and use the results to interpret the relationship between incomes and governance focusing on the Latin America and Caribbean region—within a worldwide empirical context. Finally, the authors speculate about the potential importance of elite influence and state capture in accounting for the surprising negative effects of per capita incomes on governance, present some evidence on such capture in some Latin American countries, and suggest priorities for actions to improve governance when such pernicious elite influence shapes public policy.

This paper - a joint product of the World Bank Institute and the Development Research Group - is part of a larger effort in the Bank to generate and analyze worldwide governance indicators, assessing the manifestations and consequences of governance.

Abstract:
In recent years, the growing interest of academics and policymakers in governance has been reflected in the proliferation cross-country indices measuring various aspects of governance. In this paper we explain how a simple variant of an unobserved components model can be used to combine the information from these different sources into aggregate governance indicators. The main advantage of this method is that it allows us to quantify the precision of the both individual sources of governance data as well as the aggregate governance indicators. We will illustrate the methodology by constructing aggregate indicators of bureaucratic quality, rule of law, and graft, for a large sample of 160 countries. Although these aggregate governance indicators are more informative about the level of governance than any individual indicator, the standard errors associated with estimates of governance are still large relative to the units in which governance is measured.

Abstract:
The evidence from individual cases and from cross-country analysis supports the view that globalization leads to faster growth and poverty reduction in poor countries. To determine the effect of globalization on growth, poverty, and inequality, Dollar and Kraay first identify a group of developing countries that are participating more in globalization. China, India, and several other large countries are part of this group, so well over half the population of the developing world lives in these globalizing economies.

Over the past 20 years, the post-1980 globalizers have seen large increases in trade and significant declines in tariffs. Their growth rates accelerated between the 1970s and the 1980s and again between the 1980s and the 1990s, even as growth in the rich countries and the rest of the developing world slowed. The post-1980 globalizers are catching up to the rich countries, but the rest of the developing world (the non-globalizers) is falling further behind.

Next, Dollar and Kraay ask how general these patterns are, using regressions that exploit within-country variations in trade and growth. After controlling for changes in other policies and addressing endogeneity with internal instruments, they find that trade has a strong positive effect on growth.

Finally, the authors examine the effects of trade on the poor. They find little systematic evidence of a relationship between changes in trade volumes (or any other measure of globalization they consider) and changes in the income share of the poorest - or between changes in trade volumes and changes in household income inequality. They conclude, therefore, that the increase in growth rates that accompanies expanded trade translates on average into proportionate increases in incomes of the poor. Absolute poverty in the globalizing developing economies has fallen sharply in the past 20 years. The evidence from individual cases and from cross-country analysis supports the view that globalization leads to faster growth and poverty reduction in poor countries.

This paper - a product of Macroeconomics and Growth, Development Research Group - is part of a larger effort in the department to study the effects of globalization on the poor.

Abstract:
A key issue today is the effect of globalisation on inequality and poverty. Well over half the developing world lives in globalising economies that have seen large increases in trade and significant declines in tariffs. They are catching up the rich countries while the rest of the developing world is falling farther behind. Second, we examine the effects on the poor. The increase in growth rates leads on average to proportionate increases in incomes of the poor. The evidence from individual cases and cross-country analysis supports the view that globalisation leads to faster growth and poverty reduction in poor countries.

Abstract:
The Worldwide Governance Indicators, reporting estimates of six dimensions of governance for over 200 countries between 1996 and 2005, have become widely used among policymakers and academics. They have also attracted some explicit written criticisms. In this short paper the authors synthesize 11 critiques offered by four recent papers. They then refute them as either conceptually incorrect or empirically unsubstantiated.

Governance Indicators, National Governance, Statistical & Mathematical Sciences, Economic Policy, Institutions and Governance, Public Sector Corruption & Anticorruption Measures

Abstract:
When average incomes rise, the average incomes of the poorest fifth of society rise proportionately. This holds across regions, periods, income levels, and growth rates. But relatively little is known about the broad forces that account for the variations across countries and across time in the share of income accruing to the poorest fifth.

When average incomes rise, the average incomes of the poorest fifth of society rise proportionately. This is a consequence of the strong empirical regularity that the share of income accruing to the bottom quintile does not vary systematically with average income. Dollar and Kraay document this empirical regularity in a sample of 92 countries spanning the past four decades and show that it holds across regions, periods, income levels, and growth rates.

Dollar and Kraay next ask whether the factors that explain cross-country differences in the growth rates of average incomes have differential effects on the poorest fifth of society. They find that several determinants of growth - such as good rule of law, openness to international trade, and developed financial markets - have little systematic effect on the share of income that accrues to the bottom quintile. Consequently, these factors benefit the poorest fifth of society as much as everyone else. There is some weak evidence that stabilization from high inflation and reductions in the overall size of government not only increase growth but also increase the income share of the poorest fifth in society. Finally, Dollar and Kraay examine several factors commonly thought to disproportionately benefit the poorest in society, but find little evidence of their effects. The absence of robust findings emphasizes that relatively little is known about the broad forces that account for the cross-country and intertemporal variation in the share of income accruing to the poorest fifth of society.

This paper - a product of Macroeconomics and Growth, Development Research Group - is part of a larger effort in the group to study growth and poverty reduction. The authors may be contacted at ddollar@worldbank.org or akraay@worldbank.org.

Abstract:
Progress in measuring governance is assessed using a simple framework that distinguishes between indicators that measure formal rules and indicators that measure the practical application or outcomes of these rules. The analysis calls attention to the strengths and weaknesses of both types of indicators as well as the complementarities between them. It distinguishes between the views of experts and the results of surveys and assesses the merits of aggregate as opposed to individual governance indicators. Some simple principles are identified to guide the use and refinement of existing governance indicators and the development of future indicators. These include transparently disclosing and accounting for the margins of error in all indicators, drawing from a diversity of indicators and exploiting complementarities among them, submitting all indicators to rigorous public and academic scrutiny, and being realistic in expectations of future indicators.

H1, O17

Abstract:
Scholars, policymakers, aid donors, and aid recipients acknowledge the importance of good governance for development. This understanding has spurred an intense interest in more refined, nuanced, and policy-relevant indicators of governance. In this paper we review progress to date in the area of measuring governance, using a simple framework of analysis focusing on two key questions: (i) what do we measure? and, (ii) whose views do we rely on? For the former question, we distinguish between indicators measuring formal laws or rules 'on the books', and indicators that measure the practical application or outcomes of these rules 'on the ground', calling attention to the strengths and weaknesses of both types of indicators as well as the complementarities between them. For the latter question, we distinguish between experts and survey respondents on whose views governance assessments are based, again highlighting their advantages, disadvantages, and complementarities. We also review the merits of aggregate as opposed to individual governance indicators. We conclude with some simple principles to guide the refinement of existing governance indicators and the development of future indicators. We emphasize the need to: transparently disclose and account for the margins of error in all indicators; draw from a diversity of indicators and exploit complementarities among them; submit all indicators to rigorous public and academic scrutiny; and, in light of the lessons of over a decade of existing indicators, to be realistic in the expectations of future indicators.

Governance Indicators, National Governance, Public Sector Corruption & Anticorruption Measures, Economic Policy, Institutions and Governance, Banks & Banking Reform

Abstract:
Aid works best when it is directed to countries with relatively good institutions and policies. But how should good governance be measured, and how can aid allocation rules be designed in light of the strengths and weaknesses of existing measures? We address in brief a number of methadological and applied challenges, motivated by the U.S. government's recent proposal to allocate resources from the new Millennium Challenge Account (MCA), although the issues and recommendations apply more broadly. Among others, we discuss the implications of margins of error in governance data, the difficulties in measuring trends, and the need to complement existing cross-country indicators with in-depth country diagnostics.

Millennium Challenge Account, MCA, Aid Effectiveness, Aid Allocation, Governance Indicators, Governance Data, Corruption

Abstract:
This paper examines the empirical evidence in support of the poverty trap view of underdevelopment. We calibrate simple aggregate growth models in which poverty traps can arise due to either low saving or low technology at low levels of development. We then use these models to assess the empirical relevance of poverty traps and their consequences for policy. We find little evidence of the existence of poverty traps based on these two broad mechanisms. When put to the task of explaining the persistence of low income in African countries, the models require either unreasonable values for key parameters, or else generate counterfactual predictions regarding the relations between key variables. These results call into question the view that a large scaling-up of aid to the poorest countries is a necessary condition for sharp and sustained increases in growth.

Abstract:
Capital flows to developing countries are small and mostly take the form of loans rather than direct foreign investment. Kraay, Loayza, and Serven build a simple model of North-South capital flows that highlights the interplay between diminishing returns, production risk, and sovereign risk. The model generates a set of country portfolios and a world distribution of capital stocks that resemble those in the data.

This paper - a product of Investment Climate, Development Research Group - is part of a larger effort in the group to study international capital flows.

Abstract:
How do countries hold their financial wealth? We construct a new database of countries' claims on capital located at home and abroad, and international borrowing and lending, covering 68 countries from 1966 to 1997. We find that a small amount of capital flows from rich countries to poor countries. Countries' foreign asset positions are remarkably persistent, and mostly take the form of foreign loans rather than foreign equity. To interpret these facts, we build a simple model of international capital flows that highlights the interplay between diminishing returns, production risk and sovereign risk. We show that in the presence of reasonable diminishing returns and production risk, the probability that international crises occur twice a century is enough to generate a set of country portfolios that are roughly consistent with the data.

Abstract:
Over the past decade the U.S. has experienced widening current account deficits and a steady deterioration of its net foreign asset position. During the second half of the 1990s, this deterioration was fuelled by foreign investment in a booming U.S. stock market. During the first half of the 2000s, this deterioration has been fuelled by foreign purchases of rapidly increasing U.S. government debt. A somewhat surprising aspect of the current debate is that stock market movements and fiscal policy choices have been largely treated as unrelated events. Stock market movements are usually interpreted as reflecting exogenous changes in perceived or real productivity, while budget deficits are usually understood as a mainly political decision. We challenge this view here and develop two alternative interpretations. Both are based on the notion that a bubble (the 'dot-com' bubble) has been driving the stock market, but differ in their assumptions about the interactions between this bubble and fiscal policy (the 'Bush' deficits). The 'benevolent' view holds that a change in investor sentiment led to the collapse of the dot-com bubble and the Bush deficits were a welfare-improving policy response to this event. The 'cynical' view holds instead that the Bush deficits led to the collapse of the dot-com bubble as the new administration tried to appropriate rents from foreign investors. We discuss the implications of each of these views for the future evolution of the U.S. economy and, in particular, its net foreign asset position.

Current account, net foreign assets, stock market bubbles, budget deficits

Abstract:
Over the past decade the United States has experienced widening current account deficits and a steady deterioration of its net foreign asset position. During the second half of the 1990s, this deterioration was fueled by foreign investment in a booming US stock market. During the first half of the 2000s, this deterioration has been fuelled by foreign purchases of rapidly increasing US government debt. A somewhat surprising aspect of the current debate is that stock market movements and fiscal policy choices have been largely treated as unrelated events. Stock market movements are usually interpreted as reflecting exogenous changes in perceived or real productivity, while budget deficits are usually understood as a mainly political decision. We challenge this view here and develop two alternative interpretations. Both are based on the notion that a bubble (the "dot-com" bubble) has been driving the stock market, but differ in their assumptions about the interactions between this bubble and fiscal policy (the "Bush" deficits). The "benevolent" view holds that a change in investor sentiment led to the collapse of the dot-com bubble and the Bush deficits were a welfare-improving policy response to this event. The "cynical" view holds instead that the Bush deficits led to the collapse of the dot-com bubble as the new administration tried to appropriate rents from foreign investors. We discuss the implications of each of these views for the future evolution of the US economy and, in particular, its net foreign asset position.

Abstract:
Over the past decade the U.S. has experienced widening current account deficits and a steady deterioration of its net foreign asset position. During the second half of the 1990s, this deterioration was fueled by foreign investment in a booming U.S. stock market. During the first half of the 2000s, this deterioration has been fueled by foreign purchases of rapidly increasing U.S. government debt. A somewhat surprising aspect of the current debate is that stock market movements and fiscal policy choices have been largely treated as unrelated events. Stock market movements are usually interpreted as reflecting exogenous changes in perceived or real productivity, while budget deficits are usually understood as a mainly political decision. We challenge this view here and develop two alternative interpretations. Both are based on the notion that a bubble the 'dot-com' bubble) has been driving the stock market, but differ in their assumptions about the interactions between this bubble and fiscal policy (the 'Bush' deficits). The 'benevolent' view holds that a change in investor sentiment led to the collapse of the dot-com bubble and the Bush deficits were a welfare-improving policy response to this event. The 'cynical' view holds instead that the Bush deficits led to the collapse of the dot-com bubble as the new administration tried to appropriate rents from foreign investors. We discuss the implications of each of these views for the future evolution of the U.S. economy and, in particular, its net foreign asset position.

Abstract:
Faced with income fluctuations, countries smooth their consumption by raising savings when income is high, and vice versa. How much of these savings do countries invest at home and abroad? In other words, what are the effects of fluctuations in savings on domestic investment and the current account? In the long-run, we find that countries invest the marginal unit of savings in domestic and foreign assets in the same proportions as in their initial portfolio, so that the latter is remarkably stable. In the short run, we find that countries invest the marginal unit of savings mostly in foreign assets, and only gradually do they rebalance their portfolio back to its original composition. This means that countries not only try to smooth consumption, but also domestic investment. To achieve this, they use foreign assets as a buffer stock.

Current account adjustment, short- and long-run, international capital flow

Abstract:
Faced with income fluctuations, countries smooth their consumption by raising savings when income is high, and vice versa. How much of these savings do countries invest at home and abroad? In other words, what are the effects of fluctuations in savings on domestic investment and the current account? In the long run, we find that countries invest the marginal unit of savings in domestic and foreign assets in the same proportions as in their initial portfolio, so that the latter is remarkably stable. In the short run, we find that countries invest the marginal unit of savings mostly in foreign assets, and only gradually do they rebalance their portfolio back to its original composition. This means that countries not only try to smooth consumption, but also domestic investment. To achieve this, they use foreign assets as a buffer stock.

Abstract:
Faced with income fluctuations, countries smooth their consumption by raising savings when income is high, and vice versa. How much of these savings do countries invest at home and abroad? In other words, what are the effects of fluctuations in savings on domestic investment and the current account? In the long run, we find that countries invest the marginal unit of savings in domestic and foreign assets in the same proportions as in their initial portfolio, so that the latter is remarkably stable. In the short run, we find that countries invest the marginal unit of savings mostly in foreign assets, and only gradually do they rebalance their portfolio back to its original composition. This means that countries not only try to smooth consumption, but also domestic investment. To achieve this, they use foreign assets as a buffer stock.

Current account adjustment, short and long run, international capital flows

Abstract:
Several recent papers have attempted to identify the partial effects of trade integration and institutional quality on long-run growth using the geographical determinants of trade and the historical determinants of institutions as instruments. Dollar and Kraay show that many of the specifications in these papers are weakly identified despite the apparently good performance of the instruments in first-stage regressions. Consequently, they argue that the cross-country variation in institutions, trade, and their geographical and historical determinants is not very informative about the partial effects of these variables on long-run growth.

This paper - a product of Investment Climate, Development Research Group - is part of a larger effort in the group to study institutions and development.

Abstract:
Between 1989 and 2003, low-income countries received $100 billion in debt relief. The stated objectives for much of this debt relief have been to reduce debt overhang and to free up recipient government resources for development spending that would otherwise have been used for debt service. In this paper, we empirically assess the extent to which debt relief has been successful in meeting these objectives, using a newly-constructed database measuring the present value of debt relief for 62 low-income countries. We find little evidence that debt relief has affected the level and composition of public spending in recipient countries. We also do not find evidence that debt relief has raised growth, investment rates or the quality of policies and institutions among recipient countries. Although we cannot rule out the possibility that our failure to find evidence of positive impacts of debt relief is due to a variety of data and statistical problems, the evidence reported here does suggest that some skepticism is in order regarding the likely benefits of further large-scale debt relief.

Debt relief, HIPC, low-income countries, debt

Abstract:
Business cycles are different in rich and poor countries-because the industries in which each group of countries specialize respond differently to domestic and foreign shocks.

Business cycles are less volatile in rich countries than in poor ones. They are also more synchronized with the world cycle. Kraay and Ventura develop two alternative but noncompeting explanations for those facts.

Both explanations proceed from the observation that the law of comparative advantage causes rich and poor countries to specialize in the production of different commodities. In particular, rich countries specialize in high-tech products produced by skilled workers and poor countries specialize in low-tech products produced by unskilled workers.

Cross-country differences in business cycles then arise as a result of asymmetries among the industries in which different countries specialize. Kraay and Ventura focus on two such asymmetries.

The first, which they label the competition bias hypothesis, is based on the idea that cross-country differences in production costs are more prevalent in high-tech industries, sheltering producers from foreign competition and therefore making them large suppliers in the markets for their products.

The second, which they label the cyclical bias hypothesis, is based on the idea that production costs in low-tech industries may be more sensitive to the shocks that drive business cycles.

This paper-a product of Macroeconomics and Growth, Development Research Group-is part of a larger effort in the group to study open-economy macroeconomics.

Abstract:
Business cycles are both less volatile and more synchronized with the world cycle in rich countries than in poor ones. We develop two alternative explanations based on the idea that comparative advantage causes rich countries to specialize in industries that use new technologies operated by skilled workers, while poor countries specialize in industries that use traditional technologies operated by unskilled workers. Since new technologies are difficult to imitate, the industries of rich countries enjoy more market power and face more inelastic product demands than those of poor countries. Since skilled workers are less likely to exit employment as a result of changes in economic conditions, industries in rich countries face more inelastic labour supplies than those of poor countries. We show that each of these asymmetries in industry characteristics can generate cross-country differences in business cycles that resemble those we observe in the data.

Asymmetries, comparative advantage, labour skills, technology

Abstract:
Business cycles are both less volatile and more synchronized with the world cycle in rich countries than in poor ones. We develop two alternative explanations based on the idea that comparative advantage causes rich countries to specialize in industries that use new technologies operated by skilled workers, while poor countries specialize in industries that use traditional technologies operated by unskilled workers. Since new technologies are difficult to imitate, the industries of rich countries enjoy more market power and face more inelastic product demands than those of poor countries. Since skilled workers are less likely to exit employment as a result of changes in economic conditions, industries in rich countries face more inelastic labour supplies than those of poor countries. We show that either asymmetry in industry characteristics can generate cross-country differences in business cycles that resemble those we observe in the data.

Abstract:
Business cycles are both less volatile and more synchronized with the world cycle in rich countries than in poor ones. We develop two alternative explanations based on the idea that comparative advantage causes rich countries to specialize in industries that use new technologies operated by skilled workers, while poor countries specialize in industries that use traditional technologies operated by unskilled workers. Since new technologies are difficult to imitate, the industries of rich countries enjoy more market power and face more inelastic product demands than those of poor countries. Since skilled workers are less likely to exit employment as a result of changes in economic conditions, industries in rich countries face more inelastic labour supplies than those of poor countries. We show that either asymmetry in industry characteristics can generate cross-country differences in business cycles that resemble those we observe in the data.

International Capital Flows, Sovereigned risk, Country Portfolios

Abstract:
This paper proposes three principles for users and producers of governance indicators that both summarize the challenges in measurement and suggest ways forward: (1) all governance indicators have measurement error, (2) there are no silver bullets, and (3) the links from governance to development outcomes are complex. An overarching message is that alternative governance indicators should be viewed as complements rather than substitutes.

Governance, Corruption, Indicators

Abstract:
A correction for spatial correlation in panel data.

In many empirical applications involving combined time-series and cross-sectional data, the residuals from different cross-sectional units are likely to be correlated with one another. This is often the case in applications in macroeconomics and international economics where the cross-sectional units may be countries, states, or regions observed over time. Spatial correlations among such cross-sections may arise for a number of reasons, ranging from observed common shocks such as terms of trade or oil shocks, to unobserved contagion or neighborhood effects which propagate across countries in complex ways.

Driscoll and Kraay observe that the presence of such spatial correlations in residuals complicates standard inference procedures that combine time-series and cross-sectional data since these techniques typically require the assumption that the cross-sectional units are independent. When this assumption is violated, estimates of standard errors are inconsistent, and hence are not useful for inference. And standard corrections for spatial correlations will be valid only if spatial correlations are of particular restrictive forms.

Driscoll and Kraay propose a correction for spatial correlations that does not require strong assumptions concerning their form - and show that it is superior to a number of commonly used alternatives. This paper - a product of the Macroeconomics and Growth Division, Policy Research Department - is part of a larger effort in the department to study international macroeconomics.

Abstract:
Kraay and Nehru empirically examine the determinants of "debt distress," which they define as periods in which countries resort to exceptional finance in any of three forms: (1) significant arrears on external debt, (2) Paris Club rescheduling, and (3) nonconcessional International Monetary Fund lending. Using probit regressions, the authors find that three factors explain a substantial fraction of the cross-country and time-series variation in the incidence of debt distress: the debt burden, the quality of policies and institutions, and shocks. They show that these results are robust to a variety of alternative specifications, and that their core specifications have substantial out-of-sample predictive power. The authors also explore the quantitative implications of these results for the lending strategies of official creditors.

This paper - a joint product of Investment Climate, Development Research Group, and Heavily Indebted Poor Countries (Africa and Latin America), Poverty Reduction and Economic Management Network - is part of a larger effort in the Bank to study debt sustainability issues.

Abstract:
We study the determinants of employment and wages in the public sector, using a new set of panel data for 34 LDCs and 21 OECD countries from 1972-1992, by estimating equations suggested by an efficiency wage model. We find that government employment is positively associated with the relaxation of resource constraints (the revenue-to-GDP ratio and foreign financing in the case of developing countries and GDP per capita in the case of OECD countries), urbanization, the level of education, and certain countercyclical pressures for government hiring (the real effective exchange rate for developing countries and private employment for OECD countries). Certain measures of government wages are positively associated with government revenues and negatively associated with the level of education, government debt, and countercyclical pressures.

Abstract:
What are the effects of increased trade in goods and services on the trade balance? We study the effects of reducing transport costs in a Ricardian model with complete asset markets and find that this increases the volatility of the trade balance. This result applies regardless of whether supply or demand shocks are the main source of economic fluctuations. Both type of shocks generate fluctuations in the trade balance that are in part moderated by stabilizing movements in the terms of trade. Trade integration dampens these terms of trade movements and, for a given distribution of shocks, amplifies fluctuations in the trade balance. To overturn this result, one must assume that either trade integration is sufficiently biased towards goods with strong comparative advantage and/or risk aversion is sufficiently extreme. We calibrate the model to U.S. data and find that, for reasonable parameter values, increased trade in services could double the volatility of the trade balance.

International trade, risk sharing, trade integration, trade balance

Abstract:
What are the effects of increased trade in goods and services on the trade balance? We study the effects of reducing transport costs in a Ricardian model with complete asset markets and find that this increases the volatility of the trade balance. This result applies regardless of whether supply or demand shocks are the main source of economic fluctuations. Both type of shocks generate fluctuations in the trade balance that are in part moderated by stabilizing movements in the terms of trade. Trade integration dampens these terms of trade movements and, for a given distribution of shocks, amplifies fluctuations in the trade balance. To overturn this result, one must assume that either trade integration is sufficiently biased towards goods with strong comparative advantage and/or risk aversion is sufficiently extreme. We calibrate the model to U.S. data and find that, for reasonable parameter values, increased trade in services could double the volatility of the trade balance.

International trade, risk sharing, trade integration, trade balance

Abstract:
What are the effects of increased trade in goods and services on the trade balance? We study the effects of reducing transport costs in a Ricardian model with complete asset markets. Trade integration has three effects on the structure of the economy: a reduction in the home bias in consumption, an increase in the degree of international competition in goods markets, and a reduction in real exchange rate volatility. The reduction in the home bias increases the volatility of the trade balance regardless of the source of shocks. Except for the case where supply shocks lead to counter-cyclical trade balances, (i) the increase in international competition also increases the volatility of the trade balance; and (ii) the reduction in real exchange rate volatility increases the volatility of the trade balance if risk aversion is low but lowers it if risk aversion is high. The opposite applies when supply shocks lead to counter-cyclical trade balances. We calibrate the model to U.S. data and provide a quantitative assessment of the effects of increased trade in services on the trade balance.

Abstract:
What is the current account response to a transitory income shock? This model predicts that favorable income shocks lead to current account deficits in debtor countries and current account surpluses in creditor countries.

Kraay and Ventura reexamine a classic question in international economics: What is the current account response to a transitory income shock such as a temporary improvement in the terms of trade, a transfer from abroad, or unusually high production?

To answer this question, they construct a world equilibrium model in which productivity varies across countries and international borrowing and lending take place to exploit good investment opportunities.

Despite its conventional ingredients, the model generates the novel prediction that favorable income shocks lead to current account deficits in debtor countries and current account surpluses in creditor countries. Evidence from thirteen OECD countries broadly supports this theoretical prediction.

This paper - a product of the Macroeconomics and Growth Division, Development Research Group - is part of a larger effort in the group to study open-economy macroeconomics.

Abstract:
Small states, no different from large states in income and growth, should receive the same policy advice large states do. Because of their greater openness, they may be more vulnerable to volatility in terms-of-trade shocks - but their openness pays off in growth. Small states have attracted a good deal of research. Easterly and Kraay test whether microstates are any different from other states in income, growth, and volatility.

They find that, controlling for location, smaller states are actually richer than other states in per capita GDP. This income advantage largely reflects a productivity advantage - evidence against the idea that microstates are unable to exploit increasing returns to scale. Small states do not have different per capita growth rates, with or without controls.

Their annual growth rates are more volatile, partly because of their greater volatility in responses to terms-of-trade shocks - to which they are exposed because of their greater openness. But on balance their greater openness pays off positively in growth. Easterly and Kraay do recommend that small states diversify their risk by opening up more to international capital markets, although the benefits of doing so are still unresolved in the literature. In general, they conclude, small states are no different from large states and should receive the same policy advice large states do.

This paper - a product of Macroeconomics and Growth, Development Research Group - is part of a larger effort in the group to study the needs of small states. The authors may be contacted at weasterly@worldbank.org or akraay@worldbank.org.

Abstract:
It is difficult to choose the best model for forecasting real per capita GDP for a particular country or group of countries. This study suggests potential gains from combining time series and growth-regression-based approaches to forecasting.

Kraay and Monokroussos consider two alternative methods of forecasting real per capita GDP at various horizons:
- Univariate time series models estimated country by country.
- Cross-country growth regressions.

They evaluate the out-of-sample forecasting performance of both approaches for a large sample of industrial and developing countries.
They find only modest differences between the two approaches. In almost all cases, differences in median (across countries) forecast performance are small relative to the large discrepancies between forecasts and actual outcomes.

Interestingly, the performance of both models is similar to that of forecasts generated by the World Bank's Unified Survey.

The results do not provide a compelling case for one approach over another, but they do indicate that there are potential gains from combining time series and growth-regression-based forecasting approaches.

This paper - a product of Macroeconomics and Growth, Development Research Group - is part of a larger effort in the group to improve the understanding of economic growth. The authors may be contacted at akraay@worldbank.org or gmonokroussos@worldbank.org.

Abstract:
In Colombia, Mexico, and Morocco, firms' past exposure to foreign knowledge through exports, imported inputs, and foreign direct investment does not help to predict current product quality or productive efficiency. What mechanisms most frequently transmit foreign technologies to developing country firms? Do these foreign technologies affect both productive efficiency and product quality in the recipient firms? Under what circumstances do firms pursue activities that give them access to foreign knowledge?

To address these questions, Kraay, Soloaga, and Tybout develop a new methodology and apply the framework to plant-level panel data from Colombia, Mexico, and Morocco. Their results point to several basic messages. First, by imposing enough structure on the production function and the demand system, it is possible to measure product quality and marginal costs at the plant level and to relate the evolution of these variables to firms' activity histories. Doing so, the authors find strong firm-level persistence in both quality and marginal costs. But in most industry or country panels that they study, past international activities help little in predicting current performance once past realizations on quality and marginal cost are controlled for. That is, activities do not typically Granger-cause performance. Interestingly, in the minority of cases where significant associations emerge, international activities appear to move costs and product quality in the same direction. So the net effect on profits in these cases is not immediately apparent. Second, several basic patterns emerge with respect to the determinants of international activities. Most fundamentally, activities are highly persistent, even after unobserved heterogeneity is controlled for. That suggests that firms incur sunk threshold costs when they initiate or cease activities, so temporary policy or macroeconomic shocks may have long-run effects on the patterns of activities observed in a particular country or industry.

Also, activities tend to go together, so that studies that relate firms' performance to one international activity and ignore the others may generate misleading conclusions. But the bundling of activities seems to mainly reflect unobserved plant characteristics, such as managerial philosophy, contacts, product niche, and location. Once these are controlled for, there is little evidence that engaging in one international activity increases the probability that a firm will engage in others in the future.

This paper - a joint product of the Macroeconomics and Growth Team and the Trade Team, Development Research Group - is part of a larger effort in the group to study patterns of international technology diffusion. The study was funded by the Bank's Research Support Budget under the research project Micro Foundations of International Technology Diffusion.

Abstract:
China in the past few years has emerged as a net foreign creditor on the international scene with net foreign assets slightly greater than zero percent of wealth. This is surprising given that China is a relatively poor country with a capital-labor ratio about one-fifth the world average and one-tenth the U.S. level. The main questions that the authors address are whether it makes economic sense for China to be a net creditor and how they see China's net foreign asset position evolving over the next 20 years. They calibrate a theoretical model of international capital flows featuring diminishing returns, production risk, and sovereign risk. The calibrations for China yield a predicted net foreign asset position of -17 percent of China's wealth. The authors also estimate nonstructural cross-country regressions of determinants of net foreign assets in which China is always a significant outlier with 5 to 7 percentage points more of net foreign assets relative to wealth than is predicted by its characteristics. China's extensive capital controls can explain why its current net foreign asset position is far away from what is predicted by open-economy models and cross-country empirics. It seems reasonable to assume that China's international financial integration will increase over time. The authors calibrate and predict different scenarios out to 2025. These scenarios are necessarily speculative, but it is interesting that they typically imply negative net foreign asset positions between 3 and 9 percent of wealth. What may be counter-intuitive for many policymakers is that successful institutional reform and productivity growth are likely to lead to more negative net foreign asset positions than occurs with stagnation. Starting from China's zero net foreign assets position, it would take current account deficits in the range of 2-5 percent of GDP to reach any of these net foreign assets positions. These are not unreasonable deficits, but they require a large adjustment from the present 6 percent of GDP current account surplus.

Abstract:
The authors use preliminary results from an ongoing effort to construct estimates of debt relief to study its allocation across a sample of 62 low-income countries. They find some evidence that debt relief, particularly from multilateral creditors, has been allocated to countries with better policies in recent years. Somewhat surprisingly, conditional on per capita incomes and policy, more indebted countries are not much more likely to receive debt relief. But countries that have large debts especially to multilateral creditors are more likely to receive debt relief. The authors do not find much evidence that debt relief responds to shocks to GDP growth. Finally, most of the persistence in debt relief is driven by slowly changing country characteristics, indicating that it may be difficult for countries to exit from cycles of repeated debt relief.

External Debt, Banks & Banking Reform, Strategic Debt Management, Foreign Direct Investment, Economic Theory & Research

Abstract:
Over the past decade the US has experienced widening current account deficits and a steady deterioration of its net foreign asset position. During the second half of the 1990s, this deterioration was fueled by foreign investment in a booming US stock market. During the first half of the 2000s, this deterioration has been fuelled by foreign purchases of rapidly increasing US government debt. A somewhat surprising aspect of the current debate is that stock market movements and fiscal policy choices have been largely treated as unrelated events. Stock market movements are usually interpreted as reflecting exogenous changes in perceived or real productivity, while budget deficits are usually understood as a mainly political decision. We challenge this view here and develop two alternative interpretations. Both are based on the notion that a bubble (the 'dot-com' bubble) has been driving the stock market, but differ in their assumptions about the interactions between this bubble and fiscal policy (the 'Bush' deficits). The 'benevolent' view holds that a change in investor sentiment led to the collapse of the dot-com bubble and the Bush deficits were a welfare-improving policy response to this event. The 'cynical' view holds instead that the Bush deficits led to the collapse of the dot-com bubble as the new administration tried to appropriate rents from foreign investors. We discuss the implications of each of these views for the future evolution of the US economy and, in particular, its net foreign asset position.

Current account, net foreign assets, stock market bubbles, budget deficits

Abstract:
The validity of instrumental variables (IV) regression models depends crucially on fundamentally untestable exclusion restrictions. Typically exclusion restrictions are assumed to hold exactly in the relevant population, yet in many empirical applications there are reasonable prior grounds to doubt their literal truth. In this paper I show how to incorporate prior uncertainty about the validity of the exclusion restriction into linear IV models, and explore the consequences for inference. In particular I provide a mapping from prior uncertainty about the exclusion restriction into increased uncertainty about parameters of interest. Moderate prior uncertainty about exclusion restrictions can lead to a substantial loss of precision in estimates of structural parameters. This loss of precision is relatively more important in situations where IV estimates appear to be more precise, for example in larger samples or with stronger instruments. The author illustrates these points using several prominent recent empirical papers that use linear IV models.

Economic Theory & Research, Statistical & Mathematical Sciences, Currencies and Exchange Rates, Econometrics, Access to Finance

Abstract:
Growth is pro-poor if the poverty measure of interest falls. This implies three potential sources of pro-poor growth: (a) a high rate of growth of average incomes; (b) a high sensitivity of poverty to growth in average incomes; and (c) a poverty-reducing pattern of growth in relative incomes. I empirically decompose changes in poverty in a large sample of developing countries into these components. In the medium run, most of the variation in changes in poverty is due to growth, suggesting that policies and institutions that promote broad-based growth should be central to pro-poor growth. Most of the remainder is due to poverty-reducing patterns of growth in relative incomes, rather than differences in the sensitivity of poverty to growth in average incomes. Cross-country evidence provides little guidance on policies and institutions that promote these other sources of pro-poor growth.

poverty, growth

Abstract:
The Egyptian pound depreciated sharply between 2000 and 2005, declining by 26 percent in nominal trade-weighted terms. The author investigates the effect of the large depreciation on household welfare operating through exchange rate-induced changes in consumer prices. He estimates exchange rate pass-through regressions using disaggregated monthly consumer price indices to isolate the impact of the exchange rate changes on consumer prices. Then he uses household-level data from the 2000 and 2005 Egyptian household surveys to quantify the welfare effects of these consumer price changes at the household level. The average welfare loss due to exchange rate-induced price increases was equivalent to 7.4 percent of initial expenditure. Stronger estimated exchange rate pass-through for food items imply that this effect disproportionately affected poorer households.

Markets and Market Access, Access to Markets, Economic Theory & Research, Poverty Lines, Commodities

Abstract:
It is well known that business cycles in OECD countries exhibit a remarkable degree of synchronization. Much less known is that the peak of the OECD cycle is associated with high prices of labor-intensive products and low prices of capital-intensive ones. We document this cyclical behavior of product prices and argue that it offers an important clue as to why business cycles are so synchronized. Positive shocks in one or more countries raise the prices of labor-intensive products and, as a result, the demand for labor throughout the industrialized world. This generates increase in wages, employment and output in all industrial countries. Through this channel, shocks are positively transmitted across countries, creating a force towards the synchronization of business cycles.

OECD Cycle, International Transmission of Shocks, Commodity Trade

Abstract:
Multilateral development banks are frequently accused of defensive lending, the practice of extending new loans purely in order to ensure that existing loans are repaid. This paper empirically examine this hypothesis using data on lending by and repayments to the International Development Association (IDA), which is the largest provider of concessional development loans to low-income countries. The authors argue that key institutional features of IDA both (i) potentially create incentives for defensive lending, and (ii) enable particularly sharp tests of the defensive lending hypothesis. The authors find that there is a surprisingly robust partial correlation between disbursements on new IDA loans and repayments on existing loans. However, a closer look at the evidence suggests that defensive lending is unlikely to be a major explanation for this partial correlation.

Debt Markets, Bankruptcy and Resolution of Financial Distress, Access to Finance, Banks & Banking Reform, Economic Theory & Research

Abstract:
It is well known that business cycles in OECD countries exhibit a remarkable degree of synchronization. Much less known is that the peak of the OECD cycle is associated with high prices of labour-intensive products and low prices of capital-intensive ones. We document this cyclical behaviour of product prices and argue that it offers an important clue as to why business cycles are so synchronized. Positive shocks in one or more countries raise the prices of labour-intensive products and, as a result, the demand for labour throughout the industrialized world. This generates increases in wages, employment and output in all industrial countries. Through this channel, shocks are positively transmitted across countries, creating a force towards the synchronization of business cycles.

OECD cycle, international transmission of shocks, commodity trade

Abstract:
It is well known that business cycles in OECD countries exhibit a remarkable degree of synchronization. Much less known is that the peak of the OECD cycle is associated with high prices of labour-intensive products and low prices of capital-intensive ones. We document this cyclical behavior of product prices and argue that it offers an important clue as to why business cycles are so synchronized. Positive shocks in one or more countries raise the prices of labour-intensive products and, as a result, the demand for labour throughout the industrialized world. This generates increases in wages, employment and output in all industrial countries. Through this channel, shocks are positively transmitted across countries, creating a force towards the synchronization of business cycles.

Abstract:
Six dimensions of governance are estimated covering 199 countries and territories for four periods: 1996, 1998, 2000, and 2002. The indicators are based on several hundred individual variables measuring perceptions of governance drawn from 25 data sources constructed by 18 organizations. These individual measures are assigned to categories capturing key dimensions of governance. An unobserved-components model is used to construct six aggregate governance indicators in each of the four periods. Point estimates of the dimensions of governance are provided as well as the margins of errors for each country for the four periods. Methodological issues are also addressed, including tests for potential biases, and the interpretation and use of the data, given the estimated margins of errors for the indicators. The data and a Web-based graphical interface are available online at .
www.worldbank.org/wbi/governance/govdata2002/index.html

Chemical intolerance, environment, environmentalintolerance, hypersensitivity, MCS, multiple chemicalsensitivity, olfaction, unexplained symptoms

Abstract:
Small states have attracted a large amount of research. In this paper we test whether small states are any different from other states in terms of their income, growth, and volatility outcomes. We find that, controlling for location, small states have higher per capita GDP than other states. This income advantage is largely due to a productivity advantage, constituting evidence against the idea that small states suffer from an inability to exploit increasing returns to scale. Small states also do not have different per capita growth rates than other states. Small states do have greater volatility of annual growth rates, which is in part due to their greater volatility of terms of trade shocks. This terms of trade-based volatility is in turn due to small states' greater openness. Their greateropenness on balance has, however, a positive net payoff for growth. The one differential policy measure that might be relevant for small states is to further open up to international capital markets in order to better diversify risk, but the benefits of even that are still unresolved in the literature. We conclude that small states are no different from large states, and so should receive the same policy advice that large states do.

Keyword(s): The Caribbean; Pacific Islands; growth; volatility; trade; small states