Category Archives: economic development

Modi, Sisi & Jokowi: Three New Leaders Face the Challenge of Food & Fuel Subsidies

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In few policy areas does good economics seem to conflict so dramatically with good politics as in the practice of subsidies to food and energy.  Economics textbooks explain that these subsidies are lose-lose policies. In the political world that can sound like an ivory tower abstraction.   But the issue of unaffordable subsidies happens to be front and center politically now, in a number of places around the world.   Three major new leaders in particular are facing this challenge:  Sisi in Egypt, Jokowi in Indonesia, and Modi in India.

The Egyptian leader is doing a much better job of facing up to the need to cut subsidies than one might have expected.  India’s new prime minister, by contrast, is doing worse than expected – even torpedoing a long-anticipated WTO agreement in the process.  In Indonesia it is too soon to tell.

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Egypt’s new president, Abdel Fattah al-Sisi, did something In July that few leaders in North Africa or the Middle East had been able to accomplish before: he sharply cut longstanding fuel subsidies and allowed prices to rise (by 41% to 78% and more).   Surprisingly few protests materialized.

Egypt’s food subsidy program badly needs reform as well.  The country has been spending over $5 billion a year on food subsidies.  The price of bread has been kept so low that, famously, it is often fed to animals. Past attempts to reduce such subsidies in North African countries have brought unrest and even government overthrow.  But it looks like the Sisi government is beginning reforms here as well.  Bread subsidies have already been cut by 13 per cent.

In a sense, he had little choice.  Egypt’s fiscal path under his predecessor’s policies was unsustainable.   Even with subsidy cuts, the current government only hopes to bring the budget deficit down to 10 per cent of GDP in the coming fiscal year, as opposed to 14% otherwise.   Still, who would have expected President Sisi, who took office in a fragile political environment, to start off with far more serious fiscal reforms than Indian Prime Minister Modi, who came to office amid hopes for sweeping economic reform and with a whopping democratic majority?

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Also in July, Joko Widodo (“Jokowi”) was elected President in Indonesia, another country with a long history of fuel subsidies that it can no longer afford [currently costing $21 billion, or 13%-20% of government spending].  Outgoing President Yudhoyono took the first courageous step of raising fuel prices a year ago.  [The fuel subsidies problem is even worse in oil-producing countries like Iran, Saudi Arabia and Venezuela, where the right to dirt-cheap fuel is considered the national patrimony.  Indonesia itself is no longer an oil-exporter, in part because low domestic prices have encouraged rapid growth in fuel consumption.]  Jokowi does not take office until October, but his advisers favor cutting the remaining subsidies. He has forthrightly expressed an intention of doing so, gradually, over a 4-year period.

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Market Failure vs. Government Failure

Why do economists feel confident that they are right to oppose these commodity subsidies?  Agricultural and energy markets tend to be relatively close to the ideal of perfect competition, with large numbers of consumers on the demand side and producers on the supply side.  (Where competition in commodities is imperfect, government itself is usually the problem, not the cure.)    Thus the classic economics argument applies:  setting the price artificially low, with the motive of benefiting consumers, works to discourage production and creates a gap of excess demand that usually has to be met by rationing.    Setting the price artificially high, with the motive of benefiting producers, discourages consumption and creates a gap of excess supply that often ends up in wasteful government stockpiles.   And either way, the policy is an invitation to corruption.

Skeptics of the Invisible Hand point out that, left to themselves, private markets can fail in a number of ways.  Two of the most prominent justifications for government intervention in the marketplace are environmental externalities such as air pollution and inequality in income distribution.  What is so striking about subsidies for food and fossil fuels is that, notwithstanding that the policies are often promoted in the name of the environment or equity, in practice they usually do little to help achieve these goals and often have the opposite effect.   Less than 20% of Egyptian food subsidies go to poor people.  In India, less than 0.1 per cent of rural subsidies for LPG (Liquefied Petroleum Gas) go to the poorest quintile, while 52.6 per cent go to the richest.  Gasoline (petrol) subsidies in most countries go to the middle class; they are the ones who drive cars, while the poor walk or take public transportation.  The same is true of other forms of fossil fuel subsidies:  worldwide, far less than 20% of the benefits go to the poorest 20% of the population. 


Typically they are also ruinous for the budget, as in all three countries considered here.

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Can one single misguided policy do worse than simultaneously hurt economic efficiency, the environment, equity, corruption, the government budget, and the trade balance?  Yes it can.   It can derail the most important progress in multilateral trade negotiations of the last ten years!   This from a country, India, where a new prime minister was widely considered likely to tackle much-needed market reforms.

Agricultural subsidies sometimes seek to keep prices low (to benefit consumers at the expense of producers), especially in poor countries, and sometimes seek to keep prices high (to benefit producers at the expense of consumers), especially in rich countries. India’s policies try to do both. As a result, India has accomplished the extraordinary feat of rationing grain to consumers at artificially low prices through a card system and yet at the same time suffering excess supply from farmers, because they are paid high prices.   (Agricultural inputs are also subsidized — electricity, water and fertilizer — thereby delivering the requisite environmental damage.)  The government has had to buy up huge stockpiles of surplus rice and wheat that are rotting away [reportedlymore than 20 million tons of rice and 40 million tons of wheat reserves, at present].  The limited amount that is available for consumers is allocated in ways that are both corrupt and inconsistent with the stated goal of helping the poor.

The government would like to keep its subsidies and stockpiles. But it knows that this would violate international trade rules.  Modi has taken the unusual step of vetoing the Trade Facilitation Agreement that WTO member countries thought they had reached at a climactic summit in Bali in December.  This was to be the first substantive achievement in the long-suffering Doha Round launched in 2001.  It would have benefited all countries, including India.  But WTO agreements are supposed to require consensus.  Domestic political considerations evidently persuaded Modi to torpedo the agreement, which was to have been finalized by the end of July, if he couldn’t first extract a change in international rules to allow India permanently to keep its subsidies and its stockpiles.

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What is a leader to do?

Of course the US and other rich countries have their own distorting subsidies in agriculture and energy. The US still subsidizes oil production and Europe still subsidizes coal.  The luckiest crops include cotton, sugar, dairy products, and grain.  The subsidies often hurt environmental quality, domestic consumer pocketbooks, and producers in developing countries, as well as the budget and general economic efficiency.    But at least rich country governments don’t usually set a particular low price for an important commodity and lead consumers to think they will never have to pay more.

Once subsidies are in place, they are extraordinarily difficult to remove.  People become accustomed to the idea that the government is responsible for the price of food or energy.  If world commodity prices go up, as they often have over the last decade, citizens who are accustomed to the domestic price being set in the market are more likely to accept the reality that their officials can’t wave a magic wand to insulate them from the unpleasant shock.   But people who are accustomed to the price being set by the government do hold it responsible.  In some countries, the removal of subsidies has led to civil unrest and even the overthrow of the government.

That is a strong reason not to adopt such subsidies in the first place.  But it doesn’t necessarily mean that, once in place, keeping them is the better option for the savvy politician.  If the alternative to raising the price is shortages or rationing through long lines, that can bring angry protestors out into the streets as well.  Similarly, the procrastinating leader is unlikely to look like a political genius if ever-widening gaps force an even bigger rise in the retail price when the day of reckoning comes.  (The gaps that tend to raise the necessary adjustment over time include declining domestic supply as producers respond to low price incentives; widening trade deficits, as the commodity shortfall is imported; and growing budget deficits, as the government pays for the price difference.)

Some subsidies do find their way to the poor.  [Cooking oil is an example.]  Ideally, as a matter of compassion as well as politics, other more efficient means of supporting incomes at the bottom will be instituted at the same time that subsidies for food and energy are cut.  Developing countries have learned a lot about efficient transfer mechanisms, from policy innovations such as the Conditional Cash Transfers of Mexico’s  Progresa/Oportunidad or Brazil’s Bolsa Familia and from technological innovations such as India’s Unique Identification system.  But in countries where the adjustment does not come until a budget crisis forces it, there may be no money left for transfers to cushion the pain.

The savvy politician should probably announce the unpleasant adjustment as soon as he takes office.  That seems to be the approach of Jokowi and Sisi.  Ironic that the third politician, Modi, the one who comes in with the biggest electoral mandate and the most hype about market reforms, is the one who is already falling short.

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[A shorter version, “The Subsidy Trap,” appeared at Project Syndicate.  Comments can be posted there.]

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China Is Not Yet #1

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Widespread recent reports have trumpeted: “China to overtake US as top economic power this year.”  The claim is basically wrong. The US remains the world’s largest economic power by a substantial margin.

The story was based on the April 29 release of a report from the ICP project of the World Bank: “2011 International Comparison Program Summary Results Release Compares the Real Size of the World Economies.”     The work of the International Comparison Program is extremely valuable.  I await eagerly their latest estimates every six years or so and I use them, including to look at China.  (Before 2005, the data collection exercise used to appear in the Penn World Tables.)

The ICP numbers compare countries’ GDPs using PPP rates, rather than actual exchange rates.   This is the right thing to do if you are looking at real income per capita in order to measure people’s living standards.  But I would argue that it is the wrong thing to do if you are looking at national income in order to measure the country’s weight in the global economy.

The bottom line for China is that by both criteria, income per capita (at PPP rates) or aggregate GDP (at actual exchange rates), it still has a ways to go until the day when it surpasses the US.  This in no respect detracts from the country’s impressive growth record, which at about 10% per annum for three decades constitutes a historical miracle.


(click on the graph for larger image)

At current exchange rates, the American economy is still almost double China’s, 83% bigger to be precise.  But the cross-over day is not far off, as the graph shows.  If the Chinese real growth rate continues to exceed US growth by 5% per annum and the yuan appreciates at 3% a year in real terms (inflation is higher there), then China will pass the US by 2021. Soon, but not imminent.

The PPP-versus-exchange rate issue is familiar to international economists.   This annoying but unavoidable technical problem arises because China’s output is measured in its currency, the yuan, while US income is measured in dollars.  How should you translate the numbers so that they are comparable?  The obvious solution is to use the contemporaneous exchange rate.  (Multiply China’s yuan-measured GDP by the dollar-per-yuan exchange rate, so that is expressed in dollars.)

Someone then points out, however, that if you want to measure the standard of living of Chinese citizens, you have to take into account that many goods and services are cheaper there.   A yuan goes further if it is spent in China than if it is spent abroad.  Some internationally traded goods have similar prices.   T-shirts are virtually as cheap in the United States as in China, in part because we can buy them from there. (Oil is almost as cheap in China as abroad, because it can import oil.)   But haircuts, a service that cannot readily be traded internationally, are much cheaper in China than in the US.  For this reason, if you want to compare income per capita across countries, you need to measure local purchasing power, as the ICP does.

The PPP measure is useful for many purposes, like knowing which governments have been successful at raising their citizens’ standard of living.  A second application is estimating whether the country’s currency is “undervalued,” controlling for its productivity.  A third is judging whether it is reasonable to expect that the country has the means to start cutting pollution.   (The turning point for sulphur dioxide in international data has been estimated at roughly $10,000 per capita in today’s dollars.  China is now there.)

Looking at income per capita, China is still a relatively poor country, even by the PPP measure and even though it has come very far in a short time.  Its income per capita is now about the same as Albania’s, in the middle of the distribution of 199 countries (99th).

But Albania doesn’t often get headlines.   Why are we so much more interested in China?  Partly because it is such a dynamic economy, but not just that.  China has the world’s largest population.  When you multiply a medium income per capita times 1.3 billion “capita,” you get a large number.  The combination of a very large population and a medium income gives it economic power, and also political power.

Why do we consider the United States the incumbent number 1 power?   Partly because it is rich, but not just that.  If income per capita were the criterion, then Monaco, Qatar, Luxembourg, Brunei, Liechtenstein, Kuwait, Norway and Singapore would all rank ahead of the US.  For purposes of that comparison, it does not much matter whether you use actual exchange rates to make the comparison or PPP rates.  Relative rankings for income per capita don’t depend on this technical choice as much as rankings of size do.  (The reason is that the PPP rates are highly correlated with income per capita, the phenomenon known as the BalassaSamuelson relationship.)

If you are choosing what country to be a citizen of, you might want to consider one of these richest countries.   But we don’t consider Monaco, Brunei and Liechtenstein to be among the world’s “leading economic powers,” because they are so small.  What makes the US the #1 economic power is the combination of having one of the highest populations together with having one of the higher levels of income per capita.

So there is a widespread fascination with the question how China’s economic size or power compares to America’s, and especially whether the challenger has now displaced the reigning champ as #1.  It seems to me that PPP rates are not the best ones for making this comparison.  Why?

When we talk about size or power we are talking about such questions as the following.  From the viewpoint of multinational corporations, how big is the Chinese market?  From the standpoint of global financial markets, will the RMB challenge the dollar as an international currency?   From the viewpoint of the IMF and other multilateral agencies, how much money can China contribute and how much voting power should it get in return?   From the viewpoint of countries with rival claims in the South China Sea, how many ships can its military buy?   For these questions, and most others where the issue is total economic heft, you want to use GDP evaluated at current exchange rates.  It’s how much the yuan can buy on world markets that is of interest, not how many haircuts or other local goods it can buy back home.

It is sometimes objected that using the current exchange rate subjects the comparison to the substantial fluctuations that exchange rates often exhibit.   This is true.   But the large and variable measurement errors in the PPP adjustment are considerably worse.  There is a good case for using a five-year average of the exchange rate instead of the exchange rate in one particular year. It doesn’t make much difference for the US-China comparison during this period.  But even when exchange rate fluctuations seem large, the difference is relatively small compared to the other statistical issues at stake here.

[A shorter op-ed version of this article appeared at Project Syndicate. Comments can be posted there. A version at VoxEU will include references.]

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The Ibrahim Prize for Excellence among African Leaders

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     On October 14, the Mo Ibrahim Prize Committee announced, for the second year in a row, that it had not found anyone to whom to award its Prize for Achievement in African Leadership.

The Prize is given to a recently-retired Executive Head of State or Government in Africa who satisfies the criteria of having been democratically elected, having left at the end of his or her constitutionally mandated term, and having demonstrated exceptional leadership.  The winner receives $5 million paid over ten years, followed by $200,000 annually for life, which makes it the world’s most valuable annually awarded prize

The Mo Ibrahim Foundation supports other valuable activities as well, especially the annual rating and ranking of countries in the Index of African Governance, which was also released October 14.   But I am especially intrigued by the Prize.  For me the suspense doesn’t come from seeing who will win a $5 million lottery, but rather from seeing whether the existence of such a prize can sometimes influence behavior of leaders.  It is a fascinating social policy experiment, which deserves to be more widely known.

     Even such a noble venture as this receives some criticism.  One argument goes, “Because the Ibrahim prize in many years is given to nobody, it makes Africa look bad.”   It has also been argued,  “Leaders shouldn’t have to be ‘bribed’ into being good.  The good ones will be good and the bad ones will be bad, regardless of the prize.”

I don’t buy these criticisms.   Yes, it is important to note that other parts of the world also suffer from governance problems, not just Africa.   [Who would have thought that in the 2000 US election, the presidency would be awarded, to the candidate who had received fewer popular votes, by officials who had been appointed by the father and brother of that candidate, when they ruled that the re-counting of votes in Florida should be stopped?]    More people should also be aware that many African countries have enjoyed substantial progress over the last decade, particularly with respect to economic growth, health, and education.  But these are not arguments against the Prize, which helps to highlight the important role of leadership in those African countries that have made progress.

African leaders range from good to bad, as do leaders everywhere.   It is useful to shine a spotlight on the good end of the spectrum of leaders, helping balance the abundant attention received by the truly awful ones, up to and including prosecutions by the International Criminal Court.   But, further, the amount of money that comes with the Ibrahim Prize is enough that it might go beyond honoring virtue ex post, and actually affect behavior, ex ante.   

     The Ibrahim Prize was awarded in 2007, 2008 and 2011, respectively to Presidents Joaquim Chissano of Mozambique, Festus Mogae of Botswana, and Pedro Verona Pires of Cape Verde.  Botswana and Cape Verde are two of the four small-population countries that have consistently ranked at the top in ratings of African governance, human development, and economic performance.  [The other two are Indian Ocean countries, Mauritius and the Seychelles.  It is intriguing that three of these four top performers are small island states.]   Mozambique is different: larger and historically in much worse shape by all the criteria.  It suffered a terrible civil war from 1977-1992.  Even after two decades of strong political and economic improvement it still ranks far down in the indicator lists.   

     What defines good leadership is an interesting question.  Even Harvard University’s Kennedy School of Government, where I teach, finds it hard to come up with an answer.  Should leadership be evaluated by the criterion of successfully delivering good outcomes to the country, such as economic prosperity, health, human rights, personal security, and peace?   Or are the proper criteria the quality of character and the competence of the leader, including his or her ability to inspire the country, to choose good people, to formulate good policies, and to get them put into place?    In a word, is it outcomes, or inputs?   Successful outcomes are obviously the ultimate objective; but in my view it is not useful to rely solely or primarily on outcomes to judge the quality of a leader. 

Many factors beyond the control of the leader can prevent his country from climbing to the top of the rankings.  His policies may be blocked by intransigent domestic political opposition or he may be overthrown by a coup. Or his country may be invaded by a neighbor. Even if one were to interpret good leadership as a demonstrated ability to prevail over political roadblocks no matter how strong or unfair they are, surely he should not be held responsible, for example, for the effects of droughts, floods, or other natural disasters.   Too often we evaluate the performance of the ship’s captain solely by the smoothness of the ride, or even by the perceptions of the passengers in the hold, without paying sufficient attention to whether the waters are stormy and the captain steered skillfully.   

Admittedly, the competence and integrity of the leader are more difficult to measure than outcomes (such as income per capita, life expectancy, infant mortality, literacy, crime, etc.)   But some of the component indicators of the Ibrahim Index of African Governance (IIAG) are closer to policies that are more directly under the control of the government (such as rule of law, rights, red tape, and fiscal policy).   And of course one would not expect the prize committee or historians to judge leaders solely by quantitative criteria in any case.  

On the one hand, the Foundation says it looks for leaders “who deliver security, health, education and economic development to their constituents,” which sounds like it judges by outcomes.  But on the other hand it says the award is based on “excellence in office.”  Its senior officials confirm that what matters is not the level of the country’s ranking, but whether the leader has served honorably and worked to move things in the right direction.   Past awards have been based on specific accomplishments on the part of the recipient, as opposed to high overall rankings for their countries per se. President Chissano was recognized for “bringing peace, reconciliation, stable democracy and economic progress to Mozambique following the civil war”;  President Mogae for “his role in maintaining and consolidating Botswana’s stability and prosperity in the face of an HIV/AIDS pandemic”; and President Pires for “his role in transforming Cape Verde into a model of democracy, stability and increased prosperity.”

     The list of eligible candidates each year begins with those who were democratically elected and who left office constitutionally within the preceding three years.   In a typical year there may be as few as three candidates who meet these qualifications.  The question is then whether any of them have demonstrated the necessary level of excellence in office.  Often the Prize Committee decides that none have (2009, 2010, 2012, and now 2013). 

 The question is why.  Mo Ibrahim is adamant that the paucity of winners does not mean that the Foundation should lower the bar.  Good for him.  But there might nonetheless be some way to modify the rules governing the prize.

     Consider a ruler who comes to power with great intentions and great abilities.   Assume that he in fact accomplishes much for his country during his first term, or his first two or three terms if the constitution allows it. 

But then what happens?  Often they stay too long.  (Uganda’s Yoweri Museveni comes to mind.)   They force through changes in the constitution to run for further terms in office.  Next, they may start to rig elections and suppress opposition.  They or members of their family may start fattening their overseas banking accounts.   Their personalities may have changed.   They may now regard themselves as indispensable. They have been corrupted by power, like the porcine leaders in Orwell’s Animal Farm.   At this point, the ruler is unlikely to be influenced by the existence of the Ibrahim Prize.

But consider a leader, in his last lawful term in office, who would still prefer to do the right thing: continue to serve competently and honestly in his last term and then leave voluntarily at the end.  This path might leave a retirement with few resources for him and his family, little in the way of prestige or a platform from which to speak, and perhaps persecution or even jailing by his successors.   It is precisely such a leader for whom the Ibrahim Prize could make the difference, at the margin, influencing him to continue on the high road.

     Why then doesn’t it work more often than it does?   Surely $5 million is enough to make a difference for such a person.  

Perhaps the problem is that he can’t be sure he would get the prize.  I wonder if members of the Prize Committee ever communicate with final-term sitting leaders that they will be good candidates if they go the extra mile.  If a leader’s candidacy were known among the public, the entire country might “raise its game” to help him win, in a patriotic campaign analogous to competing to host the Olympics.

The Ibrahim Foundation might consider extending the window of eligibility from 3 years to 5 or 10 years.    I can think of three arguments for doing so.

1)           Lengthening the window might help a bit with the problem that in a typical year, the committee can’t find a good enough candidate out of the pool of those who have left office in the last 3 years.  In some periods there may be multiple good candidates and in other periods there may be none.

2)     A leader in his last term in office might be more influenced by the prospects of getting the award, because if he did everything right it would be unlikely that he would subsequently lose out simply because there happened to be other good departing leaders who came along at the same time.

3)   It is easier to judge who was or was not a good leader when more time has gone by.  Famously, few Americans thought Harry Truman had been a good president immediately after his time in office, but history now rates him very highly.  [Even Abraham Lincoln was widely despised in his own lifetime.]  In Mexico, Carlos Salinas looked good at the time, but is now viewed poorly.  Meanwhile, with the perspective of history, the accomplishments of his successor, Ernesto Zedillo, now look to have been bold, historic, innovative, and valuable.  For analogous reasons, most of the scientists who receive the Nobel Prize [such as last week’s winners in Physics, Chemistry, and Medicine], did their award-winning research many years in the past.

      The Ibrahim Prize was established only in 2007.   This means that, so far, the candidates have served most of their terms in office when the Prize did not yet exist and so could not have influenced their behavior.   A leader elected in 2007 would not complete two five-year terms until 2017.  If the experiment works, the main fruits will lie in the future.

[A shorter version of this blogpost appeared as “African Leaders’ Eyes on the Prize,” at Project Syndicate.  Comments may be posted there.]


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