Breaking the Development Banks: How They Can Help and Hinder Development

Like fashion, international development is guided by trends. While some trends come and go, others withstand the test of time. If recent events are any indication, a new international development trend is on the horizon: development banks, governed by developing countries.

Awkward Family Photo

Just before the Asia-Pacific Economic Conference in Bali last October, China announced the establishment of the Asian Infrastructure Investment Bank (AIIB). As its name suggests, the bank will devote its resources to finance national and regional infrastructure development projects throughout Asia. Startup capital for the new bank is expected to be $50 billion, with aspirations to match. One of the new bank’s notable plans is constructing a railway from Beijing to Baghdad. Though ambitious, China is willing to devote its resources to the cause. According to the McKinsey Global Institute, China spent 8.5% of its GDP on infrastructure from 1992 to 2011, more than any other country in the world.

Construction

While plans for the AIIB are still underway, Brazil, Russia, India, China, and South Africa (BRICS) recently announced plans for their own bank. Like the AIIB, the New Development Bank (NDB) will finance infrastructure projects, with initial assets reaching $50 billion. An additional $100 billion will be designated for the Contingency Reserve Arrangement (CRA) for member states with suffering from severe current account deficits. Unlike the general infrastructure fund, to which all member states contributed equally, the CRA is dominated by Chinese assets. Of the $100 billion, the Chinese will contribute $41 billion with South Africa contributing $5 billion and Russia, Brazil, and India each contributing $18 billion. With the CRA, the NDB could prove a viable alternative to the IMF, and likely with fewer conditions.

In less than a year, two new development banks have taken root. Does this trend have staying power?

If anything, the new banks will remind the development community of the importance of infrastructure development. However, to be successful, the banks’ leaders must have realistic expectations with respect to international cooperation and lending capacity.

The AIIB and NDB challenge the structure of current global development institutions. The Bretton Woods system, created in 1944, reflects the economic structure of a bygone era in which the BRICS had not yet emerged. Decades later, the economy has changed though voting structure has not. The BRICS hold only 11% of the votes in the IMF, though their economies claim 20% of the world economy. A 2010 IMF agreement will redistribute some of the votes to give more weight to developing countries, thereby reducing the importance of financial contributions. The agreement, however still awaits ratification from the U.S. Congress. Until then, China, poised to be the world’s largest economy this year, will have fewer votes than Belgium, Netherlands, and Luxembourg combined.

The World Bank estimates a $1 trillion infrastructure gap for low- and middle-income countries, and the AIIB and the NDB could help to close the gap through their own financial contributions, a collective $200 billion. Cooperation with preexisting institutions, however, could be more complicated. Though sizeable, the initial capital of the AIIB and the NDB is much smaller compared to the World Bank or even the Asian Development Bank, with $232 billion and $165 billion, respectively. Cooperating with the World Bank, Asian Development Bank, and other institutions could mean that priority projects for both banks are deferred due to the financial might of its development predecessors. To be a serious alternative to preexisting institutions, both AIIB and NDB must raise additional capital.

Graph

Perhaps the most notable shortcoming is both banks’ lack of involvement in any African country save for South Africa. According to the World Bank, approximately 70% of people in sub-Saharan Africa live without access to electricity. It is puzzling as to why other African countries are given the cold shoulder, particularly Nigeria and its 170 million people, the largest in Africa. Coupled with increasing GDP growth and decreasing inflation, the country is Africa’s second largest economy, and is expected to be one of the world’s top economies by 2030. China is Africa’s largest trading partner, though the country’s trade with the continent is only a 5% share of China’s global trade. Given that Africa has some of the world’s most pressing infrastructure needs, Africa’s lack of inclusion is questionable at best.

Both banks must exercise caution in their financial management and project execution. In plans for both banks, China is set to be a chief financial contributor, however the country remains a top beneficiary of World Bank funds. China, along with Brazil and India owe a collective $66 billion in outstanding loans. Additionally, both banks must remain cognizant of the impact of infrastructure in the least developed areas. In a 2013 Center for Economic Performance paper, economist Ben Faber found that small countries with only recently connected highway systems experienced GDP growth that was on average 19% less than small countries unconnected to highway systems. This was due to the inflow of inexpensive goods that replaced demand for local goods.

While the benefits of infrastructure are numerous, it is by no means a poverty-eradicating panacea. But it is very helpful. Increased productivity and competition make infrastructure investment key driver of economic growth and a lasting trend.

Do development banks governed by developing countries have lasting power? Only time- and perhaps the international community- will tell.

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FIFA World Cup: Brazil’s Development Hopes

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Around the world, Brazil is known as the mecca of soccer. The country is loaded with magnificent soccer talent and has an electrifying atmosphere that makes soccer fanatics feel at home. Not to mention that Brazil has won the FIFA World Cup a record five times, and is the only country to have qualified for the World Cup every year since the tournament’s inception. One could not dream up a more soccer obsessed nation to host the 2014 FIFA World Cup that began this week. However, the current tension in the political, economic, and social atmosphere of Brazil has given the rest of the world an apprehensive feeling about this year’s tournament.

Political tension in Brazil has risen in recent years, as a majority of the county is unhappy with the government due to inflation, corruption, and the massive investment of public funds in World Cup preparations instead of Public Programs for the poor, who are in dire need. The estimated cost of the 2014 FIFA World Cup is currently at $11.5 billion. All this unrest comes at a time when Brazil has one of the most unequal wealth distributions in the world, currently entertaining a Gini Index of 54.7, along with a struggling economy. Some Brazilians hope that the World Cup will promote progress, while others worry that the event will push Brazil’s economy over the edge. It also gives rise to the question of whether the World Cup will only benefit the wealthy and further increase the gap between the rich and poor?

According to a recent survey by the Pew Research Center, 61% of Brazilians believe that hosting the World Cup will be detrimental to the economy as it diverts public spending away from public services. 67% also believe that the economy is in bad shape, which increased from 41% last year. Milton Hatoum, a writer from Manaus, asked: “Why does a city like Manaus need an expensive and luxurious stadium when a few meters away there’s a neighborhood, Alvorada, without sidewalks and treated sewage?”

The long-term social and economic effects of a mega-event such as the World Cup should be analyzed. To predict the path that Brazil may follow, it is helpful to take a look at the economic performance of similar World Cup host countries after the tournament. Their political, social, and economic atmospheres may vary, but this is the most direct and simple way to present the possible future outcomes for Brazil. The figures below display indicator data from the World Bank, showing the economic growth of  Argentina, Mexico, France, and South Africa since they hosted the tournament:

 

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It’s worth noting that Argentina, Mexico, and South Africa are more similar to Brazil’s economy and social structure compared to France. Argentina, Mexico, and South Africa all show a sudden rise in GDP Growth Rates, GDP, and GNI following their host year. In all four cases, the indicators suggest a short-term rise in GDP growth, followed by a decline. This gives rise to the heavily debated question of whether or not FIFA World Cup host countries see sustained long-term growth or temporary ripple effect growth following the event.

As we look ahead past this year’s FIFA World Cup, it will be interesting to see how Brazil’s economy fares. Our hope is that the result is a positive one, as the country’s economy is in need of repair. Hopefully the World Cup this summer gives the country’s economy a much-needed boost. At this point, the world will just have to wait and see.

 

 

Overnight Sensation

On April 30th, one of the major problems plaguing the economic world was partially rectified overnight. The International Comparison Project at the World Bank revised their purchasing power parity (PPP) data for 2011. PPP is a measure to balance the exchange rate between countries based on the purchasing power of of their currencies. PPP is calculated through a basket of goods. For example, if the Thai Baht is able to purchase more food relative to the US dollar, the PPP adjusts accordingly.

Graph depicting forecast of United States and China (The Economist)

One of the geopolitical implications of this change is that China’s economy is now larger than anticipated. The Economist reported that China’s PPP exchange rate is 20% larger than previously considered. This tweak of numbers means that, depending on estimates, China is the largest economy or will shortly be the largest economy in the world. Certain caveats need to be remembered, mostly that numbers self-reported by China always need to be taken with a grain of salt. That being said, the rebalancing is a reminder of what the future holds in store.

China’s inevitable rise is not the only news to come out of the International Comparison Project’s report. PPPs for 199 countries were redone, including most of the world’s developing countries. Sarah Dykstra, Charles Kenny, and Justin Sandefur from the Center for Global Development analyzed the numbers in the report and found an astonishing fact. Based on the new PPPs, global absolute poverty in 2010, defined as living on $1.25 a day, dropped from 19.7% to 11.2%. For example, Bangladesh’s GDP PPP per capita increased from $1,733 to $2,800. This revision caused 247.9 million Indians to no longer be below the absolute poverty line. It also means that more of the world’s absolute poor are now concentrated in Sub-Saharan Africa, increasing from 28% of global absolute povery to 39%. The reason for these drastic changes in figures is that inflation rates rose faster than the prices in the baskets of goods used in PPP calculations, which has been adjusted in the new 2011 numbers.

 

Global Poverty Rate (Center for Global Development)

While this may seem incredible, it merely reflects a statistical change in measurement. There is still  no consensus on whether $1.25 a day is the right measure to use for determining absolute poverty, even if it is adjusted for PPP. Other indicators have been proposed over the years. The most famous is the UNDP’s Human Development Index (HDI), attempting to include health and education along with GDP per capita. After examination, this was considered insufficient because it didn’t fully encapsulate the deprivations that poor people in developing countries face. The UNDP developed the Multidimensional Poverty Index, attempting to include things like the percent of the population that lacks a floor or clean water. As this is based on survey data, only 104 countries are included in the Multidimensional Poverty Index.

Another argument is that the difference between somebody with an income of $1.25 a day and $1.26 a day is not even negligible. Many suggest raising the line at which we measure poverty above the $1.25 a day of absolute poverty and the $2 a day of extreme poverty, with Lant Pritchett suggesting using $15 a day as the international line. What people in poor countries purchase is also vastly different from what people in developed countries purchase, negating some of the benefits of PPP. Poverty lines also vary between countries, so there have been advocates to change the global poverty line to be adjusted more frequently and be comprised of an average of developing countries.

Village in Africa, same scene before and after the ICP adjustments

This adjustment through PPP does not change the lives of those who are still living in poverty, whether their measured status changed or not by the new report by the ICP. They will still struggle to buy food and pay for school uniforms for their children, just as before. However, measuring global levels of poverty will remain important, as that which is measured gets fixed.

Watch the Throne: Nigeria is Now leading Africa in GDP

Photo Courtesy of Zouzou Wizman: https://www.flickr.com/photos/zouzouwizman/
Photo Courtesy of Zouzou Wizman: https://www.flickr.com/photos/zouzouwizman/

Nigeria has catapulted ahead of South Africa for the title of largest economy on the African continent. On April 6, Nigerian government officials announced that they had revised their 2013 GDP calculation to the tune of $510 billion. But in 2012 the World Bank estimated Nigeria’s GDP at $262 billion. So what can account for this rapid change? The answer lies in how the Nigerian government did the math.

The process is called “rebasing.” To calculate any country’s GDP, economists must first set a base year on which to model the economic growth. Then economists try to paint a picture of the economy in that year by studying different industries like agriculture, energy, and manufacturing. In the years to come, economists look at how these industries have grown. All GDP calculations, sometimes many years later, are based on this initial point of reference. However, this system of measurement does not account for the informal economy. Nor does it account for rapidly developing sectors such as telecommunications and film—industries that have sprung up in Nigeria over the last 20 years.

Nigeria’s model year was 1990. The new base year is 2010. As we will see, much has changed in the Nigerian economy since 1990. New industries have emerged and historically strong industries have fallen. Thus far, the World Bank has supported Nigeria’s recalculation. It is recommended that a country rebase its GDP numbers every five years. Since Nigeria has held off for so long, the change was quite drastic. Nigeria saw the highest gains in the service industry. The agriculture, oil, and gas industries decreased in terms of percentage of GDP. Telecommunications shot up from less than one per cent to 8.7% of GDP. The Nigerian film industry, known as Nollywood, makes up about 1.2% of GDP.

Sadly, despite these good numbers, the average Nigerian citizen will not see improvements in their quality of life. South Africa, who Nigeria unseated from the throne, has a GDP per capita of $7,336, a long way from Nigeria’s $3,000 (and that is with the new rebased numbers). There is still corruption, terrorism, power outages, and vast inequality in Nigeria. Many have criticized the new calculations, saying that nothing will ultimately change for poor Nigerians. What the new numbers can do, however, is open the door to more Foreign Direct Investment. As Africa’s largest economy, Nigeria has put itself in an advantageous position in the world marketplace by calling positive attention to themselves. As Forbes recently reported, the country is full of potential. They have a growing educated class, energy reserves, and a spirit of entrepreneurship. But as of today it seems that there remains many political and institutional barriers to overcome.

Past Reconstruction to Constructing Rwanda

Twenty years after the genocide in Rwanda, things seem to be looking a bit brighter. With an average annual growth rate of eight percent since 2001 and over one million people lifted out of poverty, Rwanda is poised to continue growing by leaps and bounds. Even so, 20% of Rwanda’s economy comes from foreign aid, only trailing its exports of coffee and tea. As with most developing countries, one of the most visible signs of growth is the new buildings sprouting from the ground around the capital of Kigali. As impressive as office buildings and shopping malls are, it remains to be seen how beneficial these structures are to the economy and people of Kigali and other developing cities.

Construction workers in Kigali

The benefits of the construction industry in developing countries is clear. The global construction industry was approximately $1.7 trillion in 2007, and typically accounts for 5-7% of each country’s GDP. Jobs in the construction sector tend to be low-skill jobs, something that most developing countries, and especially Rwanda, have in abundance. A report by the International Labor Organization (ILO) found that workers in places as diverse as India, Brazil, and China were significantly more likely to be illiterate and have few years of schooling. Construction is also an investment, as there are roads, buildings, and other structures that can be used to house offices, transport goods, and improve the human and business capabilities. Kigali is already one of the most urbanized cities in Africa, and is expected to grow by 79.9% by 2025. Construction in Kigali and satellite cities is meant to ease congestion of an already dense capital of a densely-populated country.

Map of Rwanda

There are some issues with the construction industry in the developing world. The first one involves property rights. Large amounts of people in cities in the developing world don’t have a title or ownership to the land that they live on, especially in slums. Hernando de Soto, president of the of the Institute for Liberty and Democracy in Peru, has referred to slums as “dead capital”, alluding to the idea that people make improvements by building shantytowns but are not able to use it for collateral due to red tape. The perniciousness of not actually owning the land that one’s house is built on is even worse. In Kigali, 70% of housing is informal, with the government proposing to demolish that housing and creating more high-density areas and rent-to-own schemes. However, housing in the suburbs of Kigali currently typically costs 25,000 francs ($36.87) a month in a country where 45% of people still live below the poverty line. There’s a fear that parts of Kigali could end up like Nova Cidade de Kilamba, a suburb of Luanda that is a ghost town built and funded by the Chinese.

Developing countries, and Africa in particular, have been raising questions about who benefits from the construction industry. Recent reports by investigative journalists from the Forum for African Investigative Reporters (FAIR) in Kigali have found that foreign firms, notably the Chinese, have done a substantial portion of construction. The Chinese are able to undercut local firms by using Chinese contractors backed by subsidized loans provided by the Chinese state. An operations engineer at a Chinese company working in Rwanda stated that his company could get loans with an 8% interest payment while Rwandan companies could only obtain loans with 17-18%, if they could even get a loan at all.

The view of Kigali’s town center and surrounding areas

There is a final concern about construction and corruption. Since construction contracts tend to be a fee and cost of materials, construction companies tend to be implicated more frequently. They overstate the amount of labor used on a project, pocketing the difference. One field experiment in Indonesia found that an increase in official audits of construction projects reduced missing expenditures of labor, ie nonexistent workers, by between 14 and 22%. Construction and engineering companies dominate the current World Bank list of debarred firms, the largest of which was SNC-Lavalin, a Canadian firm, which was debarred over bribery charges around the $1.2 billion funding of the Padma bridge in Bangladesh. Because of these troubling factors, questions, concerns, and confidence over construction in cities like Kigali will continue to surface.

Between a Schoolhouse Rock and a Hard Place

In both developed and developing countries, governments are trying to figure out the vital components of a successful education system. Partially, this stems from the rate of return on education, with as little as 8.5% in OECD for primary education to 25.4% in Sub-Saharan Africa for primary education as reported by the World Bank, though some of these figures are disputed. The solutions range from teacher accountability through standardized tests to competition from private schools. Some trends have been emerging from the data, and common themes are starting to become apparent.

 

Top 10 countries in categories according to PISA

Recently, the OECD came out with the results from the Programme for International Student Assessment (PISA), a cross-country test comparing the results in math, science, and reading of 15-year-old students. PISA is taken every 3 years in all 34 OECD countries, along with 31 developing countries who wish to participate, such as Jordan, Kazakhstan, Thailand, and Indonesia, among others. The stark results from this year was the drop of Finland and the rise of the East Asian states. Meanwhile, a number of developed countries underperformed the average, including the United States and Sweden. The mean score for OECD countries ended up being 494, with Shanghai-China attaining 613 and Peru propping up the table with 368.

 

Test scores and economic growth vs. years of education and economic growth.

PISA has found certain elements in school systems to be correlated with higher educational outcomes through test scores. High-performing school systems are more likely to distribute resources more evenly between socio-economically advantaged and disadvantaged areas. The better performers also tend to give more autonomy to schools, principals, and teachers over curricula and assessments than the lower performing schools. Better school systems also recruit and retain high quality teachers through higher salaries and more autonomy, although the correlation only works for countries with GDP per capita over $20,000. Finally, the less stratification there is in classes, by tracking gifted students into a separate track, the better the school test scores are.

Other reports from various academics tend to corroborate the data that OECD has been producing. Eric Hanushek and Ludwig Woessman have done a large amount of research using PISA and data from other test scores. They found that 73% of variation between test scores is down to educational quality, with a higher effect in countries below the median GDP per capita. This effect is also magnified through the openness of trade withing a country. Over a long time horizon, a 20 year reform leads to 5% higher GDP, with the effect over 75 years after the room resulting in a 36% higher GDP than without the reform. Meanwhile, the effect of dollars spent or number of years of schooling have little to no effect on educational outcomes.

 

Finnish primary education classroom

The question then turns to the factors that improve educational quality. Charles Kenny found that an increase in school autonomy over budgets, hiring teachers, and course content improves scores on average 17 points, which would be a big swing for most countries. Adding a couple hours of instruction, assessments for student promotion, and monitoring by principals for lessons makes scores leap 42 points, which would be almost a 10% improvement for the OECD average. This highlights the how autonomy and accountability complement each other. Private schools have also been shown to improve schooling in Indiaand Kenya, though other reports on private voucher programs in Chile and Catholic schools in the United States show no effect. The idea from these mixed results is that private schooling in countries with weak public institutions could benefit from private schools while in developed countries its questionable.

 

Growth and education reform

A final factor on improving educational quality is equity. Another study by Hanushek and Woessman showed that the earlier that tracking, or placing students into different classes or schools based on ability level, the more inequality there is in the system. As family socio-economic background is one of the major determinants of educational attainment, Hanushek and Woessman show that background is negated the longer that there is no tracking. This partially why Pasi Sahlberg, director of the Finnish Ministry of Education’s Center for International Mobility, has been emphasizing that the Finnish school system reformed decades ago to make education more equitable. Subsequently, test scores improved.

Education and its effect on human capital is probably one of the most important factors in development. Slowly, we are moving away from the model of just building schools, and realize that the quality of instruction also matters. In different circumstances, pre-primary education, choice in schools, autonomy, and equality have all been shown to have some impact in multiple countries. Now it’s simply a matter of determining which course of action is the best and for what circumstance.

New and Improved: Top Economies for Business Reform in 2012/2013

The World Bank’s Doing Business Index measures the ease of doing business in countries around the world. The highest-ranked countries have the simplest regulations on businesses and the strongest protections of property rights, which together enable a thriving private sector. A country’s ranking is based on its scores in ten areas: ease of starting a business, dealing with construction permits, getting electricity, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts, and resolving insolvency. The World Bank scores countries in these areas by studying laws and regulations and consulting with in-country government officials and professionals. The recently-published 2014 index ranked Singapore as best in the world, followed by Hong Kong, New Zealand, the United States, and Denmark.

Since the first Doing Business index was released in 2004, countries have made an effort to reform their regulations and remove the “bureaucratic obstacles to private sector activity” to improve their rankings on the index. The “most-improved” countries that best reformed their regulatory systems between 2012 and 2013 were Ukraine, Rwanda, the Russian Federation, the Philippines, and Kosovo. While these countries are still generally ranked low on the Doing Business index, they were able to improve their scores and their business climates in the past year.

Top Reforming Countries

Country

2013
Ranking

2014
Ranking

Ukraine

137

112

Rwanda

52

32

Russian Federation

112

92

Philippines

138

108

Kosovo

98

86

“Most Improved” Countries, 2014 v. 2013 rankings

This is not the first time Ukraine and Rwanda have been on the “most-improved” list; Ukraine placed second between 2011 and 2012, and Rwanda was ranked the second-best reformer in the six-year period between 2005 and 2011. In the past five years, the two countries have implemented reforms in every area measured in the Doing Business index.

Between 2012 and 2013, Ukraine simplified many of its complicated procedures, making many aspects of doing business in the country easier. It streamlined procedures for registering businesses and obtaining construction permits, simplified tax forms, implemented a new customs code which makes it easier to import and export, and changed the bankruptcy laws so that insolvency can be resolved easier.

During the same period, Rwanda made it easier to obtain a registration certificate for a business, streamlined the processes to obtain construction permits and transfer property, and strengthened protections for investors. Rwanda has also been using technology to streamline its business processes, implementing the online Land Administration Information System for processing land transactions, rolling out an electronic tax filing system for businesses, and introducing an electronic single-window system at the border to make cross-border trade easier.

Ukraine and Rwanda are still hardly the best places in the world to conduct business; Ukraine is ranked 112th overall, and Rwanda is ranked 32nd. Nevertheless,  these countries have been making a serious effort to improve their business environments, because doing so can lead to huge payoffs.

International businesses entering new markets look to the World Bank’s Doing Business index to determine whether they should invest in or move into a country. A good score, especially compared to a country’s regional neighbors, can help that country attract foreign direct investment, bringing capital and employers into the country. The Doing Business index is not only providing incentives for improvements in regulations and property right enforcement, but is also making it easier to track such reforms in countries like Ukraine and Rwanda.