Finance: Research, Policy and Anecdotes

When a data collection team is in the news, it is typically not good news and that is certainly the case of the Doing Business team at the World Bank. The Doing Business report has been in unfavourable news coverage quite a lot in the past years and I have written extensively about it (here and here). Two years ago , Paul Romer had to resign as Chief Economist as he (wrongly) accused the team of changing Chile’s numbers for political reasons; ultimately, it turned out to be methodological changes unrelated to political changes in Chile.  The latest alleged infringements, however, are much more serious – data were “adjusted” in return for paid advisory work in the respective country.  If true, this is corruption.  The publication of the latest report has been delayed while an investigation is taking place. Beyond this specific incident, however, there are broader governance and policy challenges.


First, the governance challenge: If one looks at the shake-up in the auditing profession a few years ago, one can see clear parallels – auditing a firm’s financial statements while at the same time providing consultancy services to this firm results in a conflict of interest. However, it took a scandal for reforms to be undertaken.  Similarly, if the same institution ranks countries and provides paid advisory services (that can help improve this ranking), this clearly creates a conflict of interest. One way out of this is to create Chinese walls within the institution between different groups; I am not privy to the institutional details of the Doing Business unit in the World Bank, but given that with few exceptions (such as the Independent Evaluation Group) all units are part of the same hierarchical structure (and under the same Executive Board where shareholders, i.e., countries, have representatives) it seems unlikely that such a structure would really work. So, unless data collection and ranking are either strictly separated with Chinese walls from the rest of the Bank or are outsourced, this governance problem is hard to solve.


Second, the policy challenge: This latest scandal brings to light broader concerns on the Doing Business database. One is the philosophical tendency towards ‘less regulation is always better” (which the Doing Business founder Simeon Djankov defended – loosely speaking – by classifying critics as Marxists). Two is the fact that rankings are taken at face value, although each country’s ranking depends on reforms (or reversal thereof) in other countries.  Three, there is the Goodhart critique: when a variable becomes a policy target, it is no longer a good gauge of what it is trying to measure. When reforms are undertaken just to improve rankings (as shown in this interesting piece on India, but certainly the case in other countries), they might not be the most important ones.  I have therefore argued previously, that the ranking should be taken out and the focus should be on the underlying data. However, even now the first graph one sees when checking on a specific country on the website are rankings. One step further than Goodhart’s law is Campbell’s law (per Justin Sandefur): “The more any quantitative social indicator is used for social decision-making, the more subject it will be to corruption pressures and the more apt it will be to distort and corrupt the social processes it is intended to monitor."


Beyond Doing Business, this controversy has implications for other databases. In the mid- to late 2000s, when I was part of a group of World Bank researchers starting data collection on financial inclusion, we discussed whether we should aim for a country ranking. Back then, I argued strongly against it, for several reasons (some of the following is discussed in more detail in this paper). One, policy makers should care about efficient and sustainable financial inclusion, not just a number. Two, the Goodhart critique also applies to the Global Findex headline indicator of the share of adults with a financial account. It is relatively “easy” to open an account for everyone in an economy through a state-owned bank; this does not imply that these are accounts are being used and that account holders are thus financially included in a meaningful way.  While the Global Findex has wisely decided not to rank countries, its headline indicator is often seen as critical policy target in many developing countries.  The underlying report, however, provides a balanced discussion, drawing on many different indicators collected. Further, the Global Findex has developed over its three rounds, with the focus expanding from bank accounts to mobile money accounts and from account ownership to use.


In summary, data are critically important – if you want to reform something, you have to measure it first. It is also clear that data collection does not and cannot take place in a completely agnostic and a-priori neutral way. We collect data on the business environment because we think it is important; we collect data on financial inclusion because we think it is important.  The World Bank is in a unique position to host such data collection efforts and I would argue that one of its main contribution to development (as part of its broader development research effort) has been exactly this. However, the World Bank has also an important responsibility in the use of these data; the use by others of World Bank data is obviously outside its control, but the way data are being presented and being used in World Bank reports sends an important signal to policy makers across the globe and other stakeholders.

So, here we are, hurtling towards a new season finale in the Brexit soap opera.  Latest twist: the oven-ready Brexit deal, approved just a few months ago by (freshly elected) Parliament “never made sense”, according to the Tory House Newspaper The Telegraph. And if you read the article, it gets even better: the WA “would leave Northern Ireland isolated from the rest of the UK, something that was ‘unforeseen’ when [Boris Johnson] agreed to it last year”. Never mind that many commentators, including Chris Grey, pointed to the consequences of the Northern Ireland frontstop, agreed to by Johnson (I wrote about it here). To claim that this was unforeseen is either perfidious or stupid!  


The reason that this comes up now is directly related to the dire state of the trade negotiations between the UK and the EU. While controls in the Irish Sea will be necessary with or without a trade deal, a no-trade-deal scenario (or trade deal with tariffs) will complicate things further, as goods coming from Great Britain into Northern Ireland will attract tariffs if at risk of being exported to the Republic of Ireland (to be reimbursed if they do not cross the non-border into the Republic). As the Telegraph quotes a senior government source, “the administrative costs would be considerable.” This statement is a bit odd, though, because the UK government just proudly announced that it is working to increase red tape (“growing the customs sector”). It should have become obvious by now that the whole Brexit soap opera is an exercise in creating red tape, not removing it, so this complaint about administrative costs is a bit odd, indeed.


Ultimately, we are back in the Brexit Trilemma: The UK decided to exit Single Market and Customs Union – this would require a customs border between Northern Ireland and the Republic of Ireland – as this is seen contrary to the Good Friday Agreement, there will have to be a customs border in the Irish Sea. Over the past four years, lots of myths have been created on how the UK can get around this (alternative arrangements, GATT article 24, Article 62 of the Vienna Convention on the Law of Treaties), but it seems Brexiters are back at their favourite past-time: staging a tantrum in the sandbox and throwing out the toys: threatening that if Withdrawal Agreement (on which Johnson won the last election) is not being changed, they will simply undermine it with domestic legislation. As pointed out by lawyers, this would simply end in a tit-for-tat with the EU, resulting in penalties and sanctions and worsening the relationship.


Which brings me to my final point: anyone who thinks that this soap opera is over one way or the other by the end of the year, should think again. The relationship between the EU and UK will be dominating UK politics for a generation to come. If there is no trade deal this fall, eventually there will have to be fresh negotiations, but with the UK in an increasingly weak position. If there is a bare-bones deal, then there will be pressure on both sides to extend such an agreement to other areas.  This is a scenario that the Swiss are well familiar with. In the case of the UK, however, this will come with the British hubris and sense of exceptionalism and with the rabid belief of Brexiters that the EU (whoever that is) is out to get them and take away their wet dreams of sovereignty.

I have just finished my third COVID-19 paper, this time on the effect of emergency loans on consumption in Iran. In this paper, joint with Mohammad Hoseini, we assess the impact of emergency loans the Iranian government offered in April to all but the richest 5% of households on consumption across different types of consumption.  Specifically, we use daily data in April/May (the Iranian month of Ordibehesht) of POS (in-store) and on-line transactions across provinces and across different types of consumption and services and different retail segments. Our treatment period is the first week after the first (and largest) loan wave, with the first three weeks as robustness test. Our control period are other days in the same month and the same month in 2019. We find that emergency loans are positively related with higher consumption of non-durable and semi-durable goods, while there is no significant effect on the consumption of durables or asset purchases, suggesting that the emergency loans were predominantly used for their intended purpose. Our coefficient estimates suggest that two thirds of the emergency loans went into non-durable rather than semi-durable consumption, with the largest increase in absolute value in consumption of food and beverages. The effects were strongest in the first few days and then dissipated over time. We find effects only for in-store but not online transactions and in poorer rather than richer provinces, suggesting that it is the poorer who reacted more strongly with higher consumption to the emergency loans.


So, all in all, the emergency loans seem to have met its objective. The fact that consumers react to temporary income changes (and even though they have to be repaid) clearly shows the existence of liquidity and credit constraints. Our findings, however, raise further questions, such as: as these support payments are in the form of loans, to be repaid starting in July-August 2020 there are concerns of repayment burdens on the lower income segments, which calls for assessing the effect of repayments (out of income subsidies) on consumption patterns. We will assess this in future work, data permitting.


A longer discussion of the paper is in this Vox column and the paper will come out shortly in the next issue of Covid Economics.

The European Council has come to a compromise on the European recovery support, after four days of negotiations. The main pillars as proposed by Macron and Merkel some time ago still stand – joint financing and an important grant element. But the grant amounts have gone down and several forward looking programmes, including support for climate change, have been reduced. So, is this a glass half empty or a glass half full?  Taking the viewpoint that a year ago none of this would have been even imaginable is a valid point if one takes the long-term view towards a slow move towards European fiscal policy integration. As my good friend Sony Kapoor points out, however, this does not take into account that the COVID-19 crisis constitutes an enormous risk to the whole European project, starting with the euro, if there is asymmetric recovery and divergence across the EU (and again, especially the euro area). Many economists, including yours truly, have therefore called early on for a joint recovery effort on the European level, on economic, political and social grounds. And as ten years ago with the banking union, when these calls were first dismissed as unrealistic, it ultimately did happen. Angela Merkel and Emmanuel Macron have stepped up to the challenge.


But the same economists (and other observers) would have preferred a bigger and more courageous deal; the GDP drop is too large for a minor effort. And though 1.75% GDP stimulus per year over the next three years sound large, it pales in comparison to a GDP drop of up to 10% this year and a potentially sluggish recovery. So, economically it might indeed not be sufficient and thus might not achieve the objective by itself.


In addition, there was the rather unpleasant picture of 27 heads of governments haggling over little details (a million here, some rebates there) and fighting tooth and nail for their national interests. This did not really inspire any positive feelings for the European project, when they are needed most. However, this is not necessarily that surprising; positive cross-border externalities of a big joint COVID-response are not taken into account by governments responsible to national electorates. And the fact that this was ultimately a political compromise among 27 governments (and to be ratified by 27 national and the European parliaments) clearly puts to the rest the accusation (often heard on this side of the English Channel) that the EU is already some kind of super-state that imposes its will on individual countries.  Rather, this compromise ensures that there is ownership for  this common recovery effort across the 27 countries of the EU!


What about the political repercussions? Yes, a failure would have strengthened populists in the South further and enabled them to openly campaign against the “useless EU” (which they might do anyway). However, one should not forget the populists in the North (EU-sceptics in the Netherlands, Finland and other countries). Having this deal be owned by 27 democratically elected governments can certainly help; seeing their head of government fight for their supposed national interest counters populist accusations of a sell-out. One may call this dirty politics, but politics has never known to be the cleanest of all professions!


Then there is the kicking the can down the road (often an outcome of EU/euro summits) – how will the joint effort be funded (to be more precise: how will the borrowing be repaid)? There is talk of Own Resources, new taxes, but no firm agreement.  More haggling and more compromises ahead, but also more possibilities for a common fiscal policy. It is clear that this was a first step and nothing else; a very small step indeed, but looking back in the future it might have been a very big step, indeed!


So, at the end, I am coming down on the glass half full side – no, this is not the big f*** deal (to quote VP Biden), it is not enough to overcome the COVID-19 challenges in the EU and even less so in the euro area.  There will have to more.  BUT: it is an important first step!  It clearly shows that fiscal policy makers are willing to step up and not leave the ECB alone. It might not have been the Hamiltonian moment, but at least it is a Hamiltonian glimpse behind the curtain, at new fiscal policy possibilities.

With Burton Flynn and Mikael Homanen, my current and former PhD students, respectively, I just published another COVID-19 paper, this time on the impact of the COVID-19 crisis on firms in emerging markets and their reaction.


Using survey responses across 488 listed firms in 10 emerging markets from early April, we find that the vast majority of firms were negatively affected by COVID-19. Firms have reacted primarily reducing investment spending and much less through layoffs. Meanwhile, some firms cut back on executive compensation, and more firms expanded employee benefits than cut them. The large majority of firms have acted before their governments imposed measures and there is a surprising degree of support vis-à-vis employees, customers, other stakeholders and broader society, in line with hypotheses stressing the importance of informal long-term relationships in emerging markets. Although stock prices initially reacted to the impact of the crisis, delayed stock price reactions suggest evidence of inefficient markets. Furthermore, we find evidence that stakeholder-centric firms (which showed flexibility vis-à-vis business partners and made donations related to the pandemic) experienced lower stock price declines during the crisis drawdown, suggesting that the financial markets valued these stakeholder-centric corporations more than their counterparts during the crisis.


This paper was made possible by ground work of Burton who is in his real job is a portfolio managers of a Finnish-based emerging markets fund, spending a month each between June 2019 and March 2020 in ten emerging markets and requested one-on-one private meetings with the CEOs of almost 1,500 listed firms.  Expect more great research with data from these meetings!


And if you are interested in Burton’s travel collecting all these great data, check out his journal: