Finance: Research, Policy and Anecdotes

There have been quite some events – some more peaceful than others – over the past weeks that have put different outspoken economists in conflict.  Take Chile where a price rise in public transport was the spark that set off week-long violent protests against the government, with wide spread destruction of public infrastructure (most notably the Santiago metro, which I fondly remember from past visits) as well as police violence. These protests came as a big surprise to many; after all, Chile has been regarded as a Latin American success story having reached high-income status and being a healthy democracy.  Obviously, not everything has been as good as it looks from the outside.  Some regard this as the ultimate proof that “neo-liberal” reforms have failed, achieving growth only for the 1% and not the 99% (to borrow one of Jeremy Corbyn’s slogans). Top of the list of “failed reforms” are pension and health insurance. What these critics seem to ignore is that income inequality has actually reduced over the past years, even though from a very high level. Throwing the baby out with the bathwater (as Jeremy would also love to do in the UK) does not seem the right answer. But two things seem problematic in Chile (and I am NOT talking as a Chile expert, simply from outside observation and drawing on broad experience in Latin American economies) – a very limited civil society and democratic participation (especially in comparison with other – European – high-income countries), with voter turnout dropping below 50% after voting stopped being mandatory, and the problem of a small market. A small economy easily allows the establishment of monopolies, especially if you have a small political and business elite and if the two are closely interlinked – so, in addition to the market not being able to maintain to many players, there is a political and thus regulatory bias in favour of incumbents. Again, I am not trying to undertake a comprehensive analysis of Chile, but this crisis certainly drives home one point (and here I am in synch with the above mentioned critics): per capita growth is not enough – income and wealth distribution is critical (where economists have moved to analyse the former, there is still limited analysis of the latter). And we also have to move beyond material achievements! In the short-run, I am most concerned about the well-being of my Chilean co-authors and friend; in the long-run, this crisis has given us lots of food for thought (and research).

 

Take next Bolivia – a coup or a public uprising? While working for the World Bank in the early 2000s, I was struck by the enormous contrast between the rich (and white) neighbourhoods (e.g., Zona Sur in La Paz) and the indigenous neighbourhoods (large parts of La Paz but especially El Alto). The early 2000s was a time of crisis and I still remember an intensive discussion with students and social activists during one of my World Bank missions – the conclusion was that much more was needed to address the underlying socio-economic problems than the technocratic solutions we were offering.  I also remember a conversation with the representative of the chamber of commerce who saw us out at the end of the meeting on bank and corporate restructuring, opened the door and said: “Well, we have had a very nice and interesting discussions, but out there – that is the real Bolivia,”, referring to the informal economy so predominant in Bolivia.  Evo Morales has brought enormous change to his country, addressing an important historic injustice by giving voice and power to the indigenous population. He managed the natural resource wave somewhat smarter than other “leftists” in the region (especially Argentina). But as so often, entrenchment in power leads to hubris and arrogance. It was pretty clear that there was cheating at the last election, which triggered the protests.  Ideally, he would have stayed on as caretaker president with a commitment not to run again (as per the referendum result in 2016), but unfortunately, the tension had raised to a point where this no longer seemed possible. One can only hope that the Bolivian political system is capable of managing the transition to peaceful elections and a new government. As in Chile, the situation in Bolivia does not lend itself to the neo-liberalism vs. socialism contrast,  but has many more facets.

 

And to round this up, there was a row about libertarianism, Marxism and the Doing Business indicators. Simeon Djankov, a former World Bank colleague of mine (and who returned to the World Bank a few months ago) dismissed criticism by economists of the Center for Global Development by referring to them as Marxists. He did make a valid point that Doing Business gauges the business environment and not economic and societal success; I disagree with him when he implies that there is no philosophy or (at a minimum) hypothesis behind the data collection - whenever you collect data, there is always some idea in the background, in the case of Simeon, one only has to consult the multiple publications that use the data. More generally, the labelling of critics with historic ideologies is not conducive at all to a fruitful debate. I have written on Doing Business before and will not warm up old debates, but we have to get back to a point where we can discuss theories, empirical findings, policies, and – most importantly – recent events without referring to silly labels and point scoring.

Financial inclusion has been at the top of the agenda for financial development researchers and policy makers over the past decade. There has been enormous progress in data collection, financial innovation and policy formulation in this area. Another important area of finance, however, has been long-term finance, the provision of long-term savings and credit services for households, enterprises and governments. It is a challenge in advanced and developing countries alike. In Europe, the objective of creating a capital market union is partly driven by the objective of more long-term financing. In developing countries, there is a remarkable long-term finance gap, with underdeveloped capital markets and contractual savings institutions and banks focusing mostly on short-term transactions. 

 

But how much long-term finance is there actually? And what are the bottlenecks to increasing the provision of long-term finance?  I have worked on this challenge across two continents - in Latin America for the Inter-American Development Bank, developing a scoreboard and undertaking country diagnostics in Colombia and Paraguay (unfortunately, only the former has been published) and in Africa for a consortium of donors, helping to develop a long-term finance scoreboard.

 

This long-term finance scoreboard was finally launched today, providing an array of data on long-term finance in Africa. Some of the data were compiled from readily available cross-country databases, other through survey work, undertaken with the invaluable help of the African Development Bank’s Statistics Department.  The result is a website which allows users to compare different countries or focus on one specific country. It presents indicators across different dimensions - the depth of long-term financial markets, access to these markets, different sources of funding and policies and institutions supporting long-term finance. Critically, it also provides the results of a benchmarking exercise, which compares countries’ indicators of long-term finance with a synthetic benchmark that takes into account the socio-economic characteristics of each country.

 

One critical factor for the financial inclusion revolution was the availability of data, which allowed benchmarking countries and progress over time and the success of policy reforms.  We hope that this long-term finance scoreboard will be the first step in a similar revolution - it starts with measuring, it continues with policy reform and it (hopefully) ends with progress.

It is always insightful to look at Brexit from a safe distance, such as Santorini where I spent the last few days relaxing. As the Brexit soap opera races towards its next season finale, many of the same themes that have become so familiar over the past 3.5 years are being revisited. And from the outside, the Westminster debate looks as ridiculous as they have over the past years, with politicians seeing Brexit as the response to a question they have forgotten. 

 

First, the Brexit trilemma is alive and kicking, with the UK wide backstop negotiated by Theresa May replaced with a Northern Ireland front-stop, taking NI effectively out of the UK customs union and internal single market. As repeated ad nauseam by many observers, only two out the following three can be achieved: no border in Ireland, UK leaving the European customs union and Single Market, and no border in the Irish Sea.  The last one had to give under Johnson’s deal, resulting in a rude awakening for the DUP who felt themselves let down not only by the Tory government but especially by the Brexiters in the ERG. 

 

Second, the utter incompetence of Tory ministers has been proven again, such as when not being able to respond whether or not there would be customs control between Great Britain and Northern Ireland (yes, there will be and they will not go away with a Free Trade Agreement between the UK and the EU as some suggested). Also, the idea that this FTA can be negotiated within the next 14 months of the transition period is on the same level as the prediction that it will be the easiest trade deal negotiated in human history. 

 

Third, the idea that Brexit will help take back control. Once Article 50 was triggered, all control was with the EU, including the option to avoid no-Deal (better described as Crash) Brexit. The same will repeat itself at the end of 2020 when the extension of the transition period has to be agreed on. And this daunting cliff will also put the UK in a weaker position during the trade negotiations. But, yes, the UK has had enough of experts who have pointed this out for the past 3.5 years!

 

Fourth, the idea that once Brexit has been “achieved”, it will all be done, the nation can find again together and the government can turn its attention to more pressing issues. The simple fact that post-Brexit the relationship of the UK not only with the EU has to be redefined, but also trade negotiations with many other countries will be informed by the future UK-EU deal tells us otherwise.  The anger on the Remainers’ side if and after Brexit happens will not go away.  Add to this the anger of Brexiters who will not get to see the blooming landscapes promised in 2016. And the continuous negotiations with the EU will give lot of opportunities to Brexiter politicians to grand-stand, threaten with the Royal Navy, appeal to the German car industry etc.

 

Can Brexit still be avoided?   Johnson has certainly been poorly advised over the past months.  He could have gotten his deal through Parliament, if not by Halloween, then by mid-November or so. But he certainly behaves like a spoiled toddler who keeps throwing his toys out of the sandbox if things do not go exactly his way. The opposition is as hopeless, I should add!  Yes, they got together to prevent a Crash Brexit. But the obvious consequence - link the new deal with a confirmatory referendum - seems not to be part of their agenda; Remainers obviously want a referendum as a last chance to reverse Brexit before it happens, but sensible Leavers (i.e., politicians who originally were in favour of Remain, but feel obliged to implement the result of the 2016 referendum) should clearly see that only a referendum will be able to settle the issue in a democratic manner, much more than a general election. 

 

As so often before, it is hard to predict what will happen next. It is unlikely that there will be Brexit next Thursday, but apart from that, many things can happen, including a General Election. And even as the EU and its member countries’ governments are losing patience with the Westminster chaos, they are unlikely to pull the plug!  Although the arguments stay the same, there is lots of new excitement to be expected in the last two months of 2019.

I just came from China where I spent an intensive week giving talks at UIBE and Peking University and meeting lots of outstanding academics (including several Tilburg/EBC alumni). I am truly impressed how the academic scene in economics and finance has developed since my last visit in 2014.  Luckily, the weather also played a positive role during the week, with a mostly blue sky. And not being able to access twitter for five days might actually have been positive for psyche.

 

One important question that came up again and again was to which extent research on the Chinese financial system is of interest and relevance for a non-Chinese audience; my response was always an emphatic yes. First, there are a number of valuable sources of micro-data, including firm- and bank-level data.  There have also been several interesting macroeconomic developments and policy changes over the past years that can be exploited (boom-bust cycle in the stock market; branch deregulation; expansion of postal savings bank into lending; changes in corporate governance rules).

 

Second, the financial system in China is a very diverse one. On the one hand, it seems antiquated, with an important role for large state-owned banks and (until recently) quite some restrictions, including on interest rates. On the other hand, financial development has leap-frogged the West, primarily in payment services but increasingly also in other areas, with an important role for BigTechs; when I asked my host whether the Chinese bills I had brought from my last visit were still valid, he laughed and said that it might be difficult to pay with cash at all.  These challenges will provide new research questions to be answered primarily with micro-data.

 

So, the question is no longer whether China is different but what we can learn from these differences between China and other countries as well as differences within China.  China stands to become not only a powerhouse in economic research but also an important source for novel research questions and data!

This year’s Nobel Prize in economics went to Abhijit Banerjee, Esther Duflo and Michael Kremer for their work on understanding development and poverty alleviation. A lot has been written about their research and the significance of this prize for the broader community of development economists but academic economists more generally (young and still active researchers as well increasing diversity), so what does a non-randomista like myself  who works with observational rather than experimental data have to add? I enjoyed both the commentary of Martin Sandbu in the FT and my former WB colleague David McKenzie. Among the few things I’d like to add are the following four:

 

First, a setting under control of researchers as in randomised control trials is now often treated as gold standard.  And even though there is an ongoing debate on the advantages and shortcomings of this approach, it certainly has raised the bar for inferring causality, including for non-experimental settings. And while some argue that the identification focus has gone too far, I am convinced that proper policy implications can only be drawn where endogeneity is successfully addressed.  By the way a discussion we have had also in journals such as Economic Policy, which never has published any randomised control trial.

 

Second, while Abhijit, Esther and Michael have applied their methodology across a large number of fields, their approach has become dominant in the field of assessing microfinance interventions and has provided very useful insights.  Having myself worked intensively in the field of financial inclusion, financial development and poverty alleviation, I see their findings as very much complimentary to the research I have done. Their findings of a moderate but not transformative effect of microcredit (as quoted in the committee’s document as “On credit, growing evidence indicates that microfinance programs do not have the development effects that many had thought when these programs were introduced on a large scale.”) is critical in assessing the role of finance for poverty alleviation and points to other channels, such as credit for SMEs and job creation, through which financial deepening can contribute to poverty alleviation.

 

Third, the increasing importance of randomised control trials has not only forced academics out of the ivory tower but also shown the importance of cooperation between researchers, practitioners and policy makers.  Researchers’ ultimate objective should be to influence the policy debate and process; addressing questions with direct policy relevance is thus critical.  This in turn implies continuous engagement with policy makers, to gain insights into their policy concerns and to feed back into the policy process.  Similarly, direct interaction with financial institutions (be they microfinance NGO or banks) is critical for both sides – access to data and research questions for researchers and influencing the structure and behaviour of these institutions. This also applies to non-randomistas. To give one example, exploiting credit registry data (often housed at central banks) can lead to a broader cooperation between central banks and researchers that result in important policy research, but also translation of research into policy actions and improvements in data collection.  

 

Finally, the RCT revolution has led to a rethinking of evaluation in the donor community.  I have been myself part of this as member of the FMO advisory panel on evaluation. And again, while little of the evaluation taking place actually relies on field experiments, the focus of development economists on experimental set-up has led to a paradigm shift in evaluation work, away from counting jobs that were supposedly created by an intervention to focusing on additionality and contribution of an intervention to an ultimate outcome.