14/06/2013 11:13Working Paper 171 - Youth Unemployment and Political Instability in Selected Developing Countries
Across the globe, the recent financial and economic crisis has led to soaring youth unemployment. In Africa for instance, youth unemployment is exacerbated by the additional challenges of a youth population which is considerably higher than other regions, narrow national labour markets and persistently high levels of poverty. More recently, the North Africa region, which has the world’s highest youth unemployment rates and where one in four young people is reported as jobless, experienced violent social uprisings in which young people played a critical role. Numerous studies suggested that large rate of youth unemployment destabilizes countries thus making them more susceptible to armed conflict (Urdal, 2006, 2012). This is broadly consistent with an increasing body of literature on the causes of political instability and conflicts, such as Collier and Hoeffler (2002) or Miguel et al (2004) to name a few. Taking advantage of this literature, this paper investigates the effect of youth unemployment on the political instability in selected developing countries. Using data from 1980 to 2010 from 24 developing countries in five regions (Africa, Latin America, the Middle East and Southeast Asia), this paper shows that political instability occurs particularly in countries where youth unemployment, as well as social inequalities and corruption are high. The results suggest that youth unemployment rate is positively and significantly associated with the measure of political instability. Specifically, doubling the unemployment rate induces an increase of the risk of political instability with a magnitude ranging between 1.06% and 1.4% depending ono the specification. These results add to a broad literature that stresses the importance of economic conditions as the most critical factors guaranteeing political stability in developing countries. This paper has a clear policy implication. In order to avoid instability and violence, focus should be on monitoring economic opportunities for young people, and particularly on providing employment or educational opportunities for youth in periods of economic decline. Creating viable jobs for young people is a precondition for sustainable development and peace in all countries; and particularly in countries which have already experienced violent conflict. However, we do recognize that political instability is a more complex phenomenon which may owe also to geo-political factors which have not been taken into account in this paper.Read more
14/06/2013 11:11Working Paper 173 - Production and Conflict in Risky Elections
Since the 1980s three major events have shaped the global environment characterising transition to a democratic political system. These are the fall of communism in the late 80s and subsequent democratic election of new leaders; various elections in sub-Saharan Africa that have installed democracies in some countries but have caused reversals in others ; and the post 2011 fall or transformation of autocracies in North Africa and Middle East and the unsteady transition to democracy that ensued. However Africa stands out as being the slowest in establishing democratic institutions and has been home to some notable reversals of democratic processes. Elections in most African countries have been challenged as not having been free and fair. Some of these elections have been marred by violence and followed by more violence once election outcomes were made public. Intuitively, an incumbent government facing elections chooses among a set of strategies. Before an election it can ensure that the country becomes productive, it can fight with the challenger (opposition), or it can produce public goods. After the election it can accept the election results, it can form a coalition with the opposition or it can refuse to leave office causing a standoff with the challenger. This paper analyzes the choices made by an incumbent, and more specifically the dynamics of the post election political process, in a game theoretic framework (2-period). To increase the endogenously determined probability of winning the election, the incumbent can fight with the challenger or produce public goods to appease the population. Winning the election is especially important if the period 2 utility is low (if a costly stand-off ensues in period 2). The paper quantifies how an incumbent strikes a balance between fighting, production and producing public goods in period 1 depending on whether the incumbent chooses to accept the election result, chooses a coalition or a standoff. This, correspondingly, impacts whether or not an election is won after period 1. The paper uses credible specific functional forms for the probability of success in contest while the probability of winning an election is determined endogenously. This allows exact analytical solutions to be computed backed by numerical simulations and compared with econometric analysis. The use of these functional forms makes it possible to determine actual strategies of the incumbent and challenger before and after an election. The econometric results bear out the approach of using these specific functional forms. The paper finds that public goods production is inverse U shaped in the incumbent’s unit fighting cost where the incumbent wins the election and remains in power (or loses and accepts the loss) and concave where the incumbent loses the election and forms a coalition. Low cost makes public goods unnecessary. Additionally, where the incumbent wins the election and remains in power, ‘high cost’ makes public goods unnecessary since the challenger faces the increasing cost. Secondly, an incumbent earning a larger resource in period 1 produces less public goods in the case where the incumbent wins the election and remains in power. Contrastingly, the incumbent earning a large resource in period 1 produces more public goods in the case where the incumbent loses and is forced to form a coalition to avoid the costly standoff. Thirdly, decreasing unit production cost causes decreasing public good provision in the case where the incumbent wins the election and remains in power or loses the election and cedes power. This result follows from the incumbent’s high period 2 utility. Fourthly, public good provision decreases in the incumbent’s unit cost of producing public goods, but more slowly for cases where the incumbent loses the election causing a standoff due to low second period utility. Fifthly, public goods production is inverse U-shaped in the parameter governing the relative importance providing public goods vis-á-vis struggling to ensure winning the election The paper also finds public goods production increases as the incumbent gets a lower share of the resources in the case where the incumbent losses the election and is forced to form a coalition. Public goods production decreases in the challenger’s fraction of unit fighting cost in the case where the incumbent loses the election and is forced to form a coalition, which makes period 2 less acceptable for the incumbent. Moreover, public goods production increases in both players’ unit production costs in the case where the incumbent wins the election and stays in office or loses and cedes power. The paper empirically tested the model using a discrete-choice logit model in order to analyze what factors determine the election outcomes. The empirical results support the deductions made in the theoretical model. The paper used a database of 653 elections in Africa over the period 1960-2010, of which 299 are presidential and 354 are legislative. Using descriptive analysis and robust multinomial logit, the study shows that the incumbent wins with no contestation 64%, coalition 6% and stand-off 2%. Out of the 653 elections held, 417 were won by the incumbent without contestation. The study find good economic performance measured by a 1% increase in GDP per capita decreases the probability of the incumbent losing by 0.0053. Therefore, doubling the per-capita GDP decreases this probability by 0.53. A 1% increase in the provision of public goods a year prior to elections increases the probability of losing and not accepting defeat by 0.0013. A 1% increase in the ethnic fractionalization index decreases the probability of the incumbent winning by 0.0034. Similarly, a 1% increase in tertiary level enrolment increases the probability of contesting the election when the incumbent has won by 0.015, while a 1% increase in religious fractionalization increases the probability of contesting the incumbent’s victory by 0.0036. The marginal effect of switching from few to abundant resources increases the probability of the incumbent losing and not accepting defeat by 0.23.Read more
19/03/2013 15:46Working Paper 170 - Development of Wind Energy in Africa
The paper describes how Africa’s wind energy markets have evolved over the years and the structural characteristics affecting the development of wind energy projects on the continent; providing what we believe is the first mapping of the continent’s wind energy market. The paper also discusses technical, environmental and financial considerations that African countries need to take into account when developing wind energy projects. Results from our analysis of 94 projects on the continent suggest that wind energy markets remain small, concentrated and nascent in nature. While we observe an increasing trend in the number and size of projects being implemented, we show that wind energy contribution to the energy mix in Africa will remain unchanged over the long term. A key observation in the paper is that wind energy has limited potential to address the issue of access to electricity in Africa mainly due to the intermittent nature of electricity output from wind power plants. Wind energy is more likely to complement electricity generation from conventional sources, as has been observed in more mature markets. We estimate the cost of the 1.1 GW installed wind power capacity in Africa at USD 1.8 billion, out of which 59 percent was contributed by development finance institutions as non-concessional funding. We also notice a shift from the use of concessional funding on projects towards non-concessional funding from development finance institutions, an increasing participation of the private sector and greater use of specialized funds and Clean Development Mechanism funding. There is also emerging south-south cooperation with some experienced African firms seeking new markets across the continent. The paper finds that the public sector remains a key player in the wind energy sector, not only as a financier but also as a local partner that ensures smooth project implementation. The paper recommends the designation of national entities dedicated to the promotion of renewable energy. Country experience shows that having national champions helps develop the sector by offering a single focal point for regulation, financing and oversight. In some instances, local agencies could be created but this is not the only route to promote the sector since well-established utilities or divisions within them could play that role ensuring policy continuity. Countries with sizeable wind energy markets such as Egypt, Morocco and South Africa, should design and implement robust policies to encourage local manufacturing of wind turbine components. Local manufacturers should be supported by governments and development partners to make them more competitive and able to bid for large scale projects. Interventions to develop the sector should be adapted to country contexts. Country experiences show that wind energy markets face different constraints and could be developed using different paths. While Tunisia and Egypt had a public sector-led development strategy, Morocco relied more on private procurement of wind energy projects. Kenya adopted the feed-in tariff mechanism, while Egypt and Morocco used a process involving competitive bidding and direct negotiation. It is also demonstrated that private investors are willing to invest in the sector as long as a clear regulatory framework is in place and wind resources are geo-referenced to gauge feasibility. The public sector therefore has a vital role to play in creating a conducive environment to attract private investors while at the same time investing in upstream operations such as feasibility studies that would pave the way for further sectorial development.Read more
19/03/2013 15:45Working Paper 169 - Monetary Policy and Exchange Rate Shocks on South African Trade Balance
This paper investigates the effects of contractionary monetary policy and exchange rate appreciation shocks on the South African trade balance using vector autoregressions. Thereafter, we identify the dominant channel between income and expenditure switching through, which monetary policy impacts the trade balance and whether policy shocks are transmitted through export or import components. Consistent, with South African policy discussion, we focus on the contributions of the trade balance to gross domestic product and assess the long-run neutrality effects of both the exchange rate and monetary policy on the trade balance. This will assist policymakers’ understanding of the trade balance as a potential driver of economic growth and to identify which component of the trade balance is sensitive to these policy shocks. In addition, we identify how much of the deterioration in the trade balance can be attributed to monetary policy directly, relative to the indirect effects of the exchange rate, ceteris paribus. Using recursive and sign restricted vector autoregressions, we find that a one standard deviation exchange rate appreciation shock lowers the trade balance as a percentage of gross domestic product significantly over more quarters compared to contractionary monetary policy shock. The contractionary monetary policy shock significantly reduces the trade balance confirming the existence of the expenditure switching channel rather than the income effect. The evidence of the expenditure-switching channel suggests that, in the short-run, ceteris paribus, monetary policy can change the direction of demand between domestic output and imported goods through the exchange rate adjustment. Both the exchange rate appreciation and monetary policy shocks worsen the trade balance through imports rather than the exports. Monetary policy worsens the trade balance by more than 0.01 percentage points at the peak when allowed to directly affect the exchange rate relative to when the channel is left unrestricted. This means that, when the fundamental determinants of the exchange rate consistent with the sticky price or flexible exchange rate models are weak, changes in monetary policy magnify the decline in the trade balance via the exchange rate. There are two policy implications from this analysis. Firstly, a significant deterioration in net exports due to the exchange rate appreciation shock indicates that the contribution of net exports to the gross domestic product will remain depressed for longer periods. Hence, this finding does not violate the neutrality of exchange rate effects on long-run economic growth. Secondly, evidence of the expenditure-switching channel, ceteris paribus, suggests that, in the short-run, monetary policy can be used to change the direction of demand between domestic output and imported goods through the adjustment in the exchange rate. However, monetary policy does not offer a long lasting solution in triggering growth via the trade balance channels as it tends to have only temporary effects.Read more
26/02/2013 14:30Working Paper 168 - Competition and Market Structure in the Zambian Banking Sector
This study evaluates the degree of competition in the Zambian banking sector in the wake of dynamic market shifts induced by entry of new foreign banks and privatisation of the state-owned bank. Using an unbalanced panel of bank level data complemented with market factors from 1998 to 2011, we measure using the Panzar-Rosse H-statistic and the time varying Lerner index, two non-structural measures mostly applied in the banking industry, see for instance. These indices are estimated across two periods with a view to assess whether or not increased foreign bank presence observed since 2008 and privatisation of the state owned bank in 2007 have had a discenible impact on competition in the Zambian banking setcor. We classify these periods as pre-entry/pre-privatisation and post-entry/post privatisation, respectively. Ther results are then compared. Zambia initiated far reaching financial sector reforms in 1992. The reforms brought great anticipation that competition in the banking system would be enhanced, thus leading to improved provision of financial services after many years of financial repression. However, expectations have been broadly at variance with practical observations. The banking system is concentrated and segmented with four largest banks controlling a third of the industry assets and about three quarters of the loans market. Intermediation margins are also wide, even by regional standards, despite marked improvements in macroeconomic conditions. Between 1998 and 2011, the average net interest margin was about 6% while the equivalent measure for return on assets stood at more than 4%. High profits and wide spreads are reminiscent of the high level of concentration in the sector. Nonetheless, commercial banks in Zambia have continued to show resilience after the banking crisis of the mid-1990s which saw closure of more than 6 banks. Currently, a majority of banks hold capital balances above the regulatory threshold, depicting the strength and stability of the Zambian banking sector. Thus, the failure of financial liberalisation to generate a 'critical level' of competitive pressure stems largely from the inherent nature of the Zambia banking system, with incumbent large foreign banks firmly entrenched in all segments of the market. However, concentration ratios distort the picture of competition because they do not offer adequate and conclusive explanations of actual bank behaviour. In view of this, appropriate measures are required to accurately assess banks’ exercise of market power and competitive conduct. Empirical results from the H-statistic show that Zambian banks earned their revenue under conditions of monopolistic competition. This finding is consistent with the estimate of the Lerner index which suggests that the degree of competitiveness may not be as low as previously understood, especially among foreign banks. Encouragingly, domestic banks also experienced intensification of competitive pressures over the sample period. Risk taking, revenue diversity and regulatory intensity are all important determinants of market power. Tight monetary policy is also found to strengthen the banks’ exercise of market power. Macroeconomic instability, denoted by inflaiton, limits banks’ competitive conduct while a large capital buffer is mainly aimed at maintaining banks’ solvency but it imposes a limit on competitive behaviour. The results also show that more geographically diversified banks have a higher propensity to raise revenue than those with a smaller branch network, and therefore useful in stimulating competition. Benchmarking Zambia against regional peers, the results show that Zambia ranked above countries of the EAC, except Kenya, which exhibited the highest degree of contestability in the region. Generally, the findings lend support to previous research suggesting that foreign bank penetration and privatisation can heighten competitive pressures in the banking sector. Thus, for policy purposes, the analysis shows that competitive conditions could be further enhanced by easing regulatory impediments and in the long-run, allowing more foreign bank participation could spur competitive conduct in the industry.Read more
26/02/2013 14:28Working Paper 167 - Promoting Economic Reforms in Developing Countries Rethinking Budgetary Aid?
This paper aims to contribute to the current debate on budget support by exploring approaches likely to strengthen the linkages between budget support and reforms in the recipient countries. In this regard, the paper introduces the distinction between “Reforms requiring tangible assets creation” and “Reforms requiring intangible assets creation”, and shows that budget support has a comparative advantage in the financing of reforms requiring intangible assets creation, while project aid has a comparative advantage in the financing of reforms requiring tangible assets creation. The paper further argues that in order to lead to lasting changes in economic behavior and, therefore, to have a real impact on the economy, a reform must have a financial effect on at least one category of economic agents. The paper argues for the proper identification of the changes in economic behavior sought by reform, together with a careful evaluation of the associated financial incidence. These have been important missing links in current donors’ practices in the use of budgetary aid to promote economic and structural reforms in developing countries. To remedy the noted decline of the role of budget support as a catalyst for structural reforms in recipient countries this paper proposes a new instrument for donors, namely, Enhanced Budget Support (EBS). The latter advocates for the following: i) that budget support should be devoted to implementing reforms requiring intangible assets creation; ii) a clearer identification of the changes in economic behaviors and, therefore, the results, targeted by the reforms, and iii) assessing the budgetary cost of the reforms to be implemented as well as calibrating the financing for budget support in light of the estimated budgetary cost, a practice that few donors currently follow. In addition to fostering greater transparency, this approach would enable stakeholders to better guarantee accountability of the authorities responsible for managing economic policy. The challenges often encountered in estimating the budgetary cost of reforms, can also be overcome. At the country level, a number of factors can create an enabling environment for the successful use of EBS. They include the following three: i) a risk-minimizing national fiduciary framework; ii) a stability-oriented macroeconomic framework; and iii) existence of sufficient analytical capacity. Directions for future research on budget support. Future research on budget support should focus on addressing the following issues: i) identification of reform actions requiring intangible asset creation; ii) costing of reform preparation and implementation; iii) relationship between the financial effect of reform measures and economic agents’ behaviours in respect of demand and production; iv) restructuring of recipient countries’ budgets to create financial space for implementing the reforms; v) improving the fiduciary systems of recipient countries; and vi) assessment of the budgetary impact of reforms.Read more
26/02/2013 14:26Working Paper 165 - Tax resource mobilization and its impact on household living standards evidence from Niger
This study analyzes the impact of indirect taxes (VAT in particular) on the living conditions of households in Niger and, accordingly, on poverty reduction in Niger. Tax policy is one of the tools through which public action can impact poverty reduction. The impact may be reflected in terms of growth as well as redistribution. A review of Niger’s revenue has shown that the country has one of the lowest tax collection rates in WAEMU. Niger's tax ratio was 13.9% in 2009 and 10.1% on average over the period 1998-2005, which is below the WAEMU average of 14% of GDP during the same period. Informality is predominant in Niger, including the non-taxation of the agricultural sector is unique to Niger. Indeed, the agriculture sector contributes one-third of GDP, is exempt from taxes. This deliberate choice by the Nigerien government was intended to protect the rural population, and its food consumption needs. The quantitative analysis of the impact of taxes on household living standards utilized graphical methods in parallel with econometrics tools. The results showed that taxes (VAT mostly) have a negative impact on household living standards. Moreover, an increase in taxes has a more pronounced impact on household consumption expenditures than an increase in household income. The purchasing power of Nigerien households has not changed substantially incomes have remained flat since the 2005 household survey was conducted. Accordingly, for the great majority of the population, particularly the poorest households, the burden of indirect taxes weighs on their ability to pay for consumption expenditures. An increase in indirect taxes, if not combined with a pro-poor social transfer policy, aggravates the unequal distribution of income among population groups. While expanding the scope of application of VAT can lead directly to increased tax receipts, the risk of such a choice is to decrease the purchasing power of those in greatest need. The implementation of pro-poor social redistribution policies through increased tax revenue mobilization could have a positive impact on poverty reduction. Yet the subsidiary question is how to raise additional tax resources without aggravating inequalities and poverty in the country? In terms of recommendations, continued reforms are necessary to adapt the tax system in a changing environment and control the economic and social cost of raising revenue. The right combination must be found to generate an optimal level of mandatory taxes, representing at least the WAEMU community standard, while reconciling efficiency and equity to the extent possible.
The paper has the following recommendations:
26/02/2013 11:22Working Paper 166 - Misalignment of Real Effective Exchange Rates: When Should the Franc CFA be Devalued Again?
The Euro area continues to be the largest trading partner of the franc zone countries with a very important share (more than 70 per cent of trade) in half of the 14 countries. Membership of this zone has the advantage of restraining inflation over the long term. The common currency has also been used as a basis for regional integration with strong institutions. However, compared to other African countries, the franc zone countries are less competitive in international markets and seem less equipped to counteract some exogenous shocks, which partly explain their low growth rates compared to other Sub-Sahara Africa countries. Starting from 2003, due to the appreciation of the euro against the dollar, the CFA franc (CFA) has gradually appreciated against the dollar until rumors circulated at the end of 2011 regarding CFA devaluation. Our main objective is to check the veracity of these rumors: Will the CFA Franc have to be devaluated again? We use macro-analytical framework to calculate the equilibrium real effective exchange rate as well as the percentage of CFA misalignment compared to this equilibrium value. Over the 2001-2011 period, there has been a tendency for a CFA overvaluation, which has fueled rumors. The misalignment curve of the CFA seems closely linked to the exchange rate euro/dollar except in the case of price increases in major commodities exported by each country. In 2011, half of the franc zone countries (Benin, Burkina Faso, Congo, Guinea Bissau, Equatorial Guinea, Mali and Niger) were in a situation of real overvaluation. We conclude that there is no need for a devaluation of the CFA franc as the misalignment is not very important and the shock would have adverse effects on the economies as it had during the 1994 devaluation. However, the tendency toward overvaluation is likely to continue because of the weak economic performances in Europe. It should lead the monetary authorities of the franc zone to ponder about the future of their fixed exchange rate regime, which ties their hands to the uncertain future of the Euro-zone. We recommend the adoption of fixed but adjustable exchange rate regime with specific, transparent rules, which are well-known in advance.Read more