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JAD
Journal of African Development
2002 | Volume 5, #2
Table of Contents
1. Capital Mobility, Saving and Investment Link: Evidence from Sub-Saharan Africa
Douglas K. Agbetsiafa
2.
Real Exchange Rate Distortions and External Balance Position of Nigeria: Issues and
Policy Options
Chukwuma Agu
3. Institutional Reform and Economic Growth in Africa
Sylvain H. Boko
4. Fertility, Education, and Market Failures
Sylvain Dessy and Stephane Pallage
5. Trade Liberalization and Customs Revenues: Does trade liberalization lead to lower
customs revenues? The case of Kenya
Graham Glenday
6. Impact of the Structural Adjustment Program on the Agricultural Sector and Economy of
Nigeria Nii O. Tackie and Odiase S. Abhulimen
7. Why do Resource Abundant Countries Have Authoritarian Governments?
Leonard Wantchekon
1
Institutional Reform and Economic Growth in Africa
Sylvain H. Boko*
Wake Forest University
Abstract: The paper estimates the impact of institutional changes on growth performance
in Africa. The study is based on a sample of 20 African countries. The findings are that
promoting economic freedom, political rights and civil liberty is growth enhancing in
Africa. This positive relationship between civil liberty and political rights in the African
context is in contrast with the results from at least one previous study conducted on the
basis of a large cross-sectional and multi-regional data set. The analysis also provides
empirical support for the strengthening of the economic and political reform programs
that are currently underway in many countries in Africa. It finds that an interaction of
political and economic freedoms does not harm development as is sometimes suggested
in the literature; it might in fact enhance it.
JEL Classification: O1 O4
*Department of Economics, Wake Forest University, Box 7505, Winston-Salem, NC,
27109. Tel: 336.758.4461; email: [email protected].
2
1. Introduction
The end of the Cold War and internal grassroots pressure in the early 1990’s
presented African countries with an opportunity to institute political and economic
reforms. The overall impact of political changes and economic reforms, and the
interaction between the two processes in the African context must continue to be studied
rigorously.
The interaction between the economy and the political environment has long
constituted a subject of interest for economists and political economists, dating back to
Hobbes, who reasoned then that there are economic gains to be made from a political
system based on safety of possession and certainty of transaction. Thus, economists have
long held the view that political changes represent changes in the institutions of
government, which can have a profound effect on a country’s economic growth. This
institutional approach to the analysis of the economic impact of government policies on
countries’ growth has been the subject of much research in the field, including Friedman
(1962 and 1981), North (1990), Knack and Keefer (1995), Dawson (1998).
The insights provided by the institutional approach have sparked a flurry of empirical
research in economic growth. For instance, Barro (1991), Barro (1996), Lian and Oneal
(1997), and Scully (1998) use large-scale, mostly cross-national studies, to analyze the
effect of such factors as state policies, economic incentives offered, political and
economic instability on the process of economic growth. Other studies, including
Carlsson and Lundström (2002), Heckelman (2000), Heckelman and Stroup (2000), Ayal
and Karras (1998), and Dawson (1998) have found that liberalizing economic polity has a
positive impact on growth.
3
It is undeniable that these large cross-country and cross regional studies are very
useful in the understanding of the relationship between economic growth and institutions.
However, it is equally undeniable that studies focused on particular regions are likely to
provide insights that are peculiar to the region, and which may be lost in the large crossnational studies. The present study conducts such a region-specific analysis.
The study attempts to contribute to the literature by conducting an empirical
investigation of the relation between economic growth, economic freedom and political
freedom as it relates to Africa. Recent publications on the growth process in Africa,
including Collier (1998), McCarty (1993), Easterly and Levine (1997), Lian and Oneal
(1997), and Sachs and Warner (1997) have focused on such social variables as ethnic or
linguistic diversity, or geographical variables such as access to the sea or type of climate
to explain the slow growth in Africa. Others, such as Mbaku (1997), argue that political
instability has a negative and significant effect on economic growth in Africa. This paper
attempts to expand that literature by focusing on the institutional forces (both political
and economic) that affect the process of economic growth in Africa. In particular, the
paper seeks to investigate if, in the presence of economic freedom, higher political and
civil liberties significantly enhance economic performance in Africa.
The motivation behind this study is manifold. First, increasingly, multilateral
institutions, including USAID, the World Bank and the IMF, are making their assistance
to countries contingent upon institutional reforms. Second, partly because of this stance
from multilateral institutions, many African countries are currently engaged in the two
types of reforms simultaneously, and studies such as the current one might provide some
direction as to the economic strength of these reforms. Third, earlier studies, including
Tanzi (1996), Prud’homme (1995), and Burki, Perry, and Dillinger (1999) have
contended that, in the case of simultaneous political and economic liberalization there
4
exists the possibility that one process may derail the other, thereby negatively affecting
the growth benefit that may derive from either policy. Thus, to examine this phenomenon
this paper incorporates into the same model the interaction between democratic reform
and economic liberalization processes in Africa, and studies their impacts on economic
growth. The idea is to discover to what extent the impact of economic liberalization on
growth in Africa depends on the political environment, and similarly to what extent the
effect of political liberalization on growth in Africa depend on economic reform.
The remaining portion of the paper proceeds as follows. Section 2 presents the model.
Section 3 describes the data and the methodology employed. The results are presented in
section 4 and section 5 concludes the paper.
2. The Model
The estimated model is similar to that used by Scully (1998) in that it focuses
exclusively on understanding the role of institutional variables in economic development.
The basic theoretical framework of analysis is borrowed from the literature (see Mankiw,
Romer and Weil (or MRW), 1992) and assumes that each economy under study is
described by a production function, exhibiting the usual characteristics (i.e., constant
returns to scale, and diminishing returns with respect to each factor individually). It is
also assumed that it is possible to derive a steady-state level of output for the model, and
that the dynamics of the path to such a steady-state equilibrium can be described.
Estimating equations can be derived from such a set-up and can be modified according to
the focus of a particular study (MRW, Dawson).
In the present case, the estimated (reduced-form) model is of the form:
y = β 0 + β1 y0 + β 2k + X Ψ + ε
(1)
5
where, y represents the growth rate of real per capita GDP over five-year intervals from
1971 to 1999; y0 (initial income) is the log of the real GDP per capita at the beginning of
each five-year period from 1971 to 1999, and ß1 is the corresponding coefficient. Further,
the variable k represents the investment ratio for the 1971-1999 period, and ß2 is the
corresponding coefficient. The matrix X contains the various freedom indexes (economic
and political), including a political-economic interaction variable. The matrix Ψ is the
vector of the corresponding coefficients. The constant is denoted by ß0, and the error term,
e, is assumed to be white noise, with mean=0 and constant variance. Initial income and
investment are the conditioning variables in the model.
Based on past studies, it is expected that increased economic freedom, civil
liberties and democracy will be positive determinants of economic growth. The sign
regarding the interaction between political and economic freedoms is ambiguous however.
The findings in the literature with respect to this are not uniform. Whereas, Mckinnon
(1997) and Qian and Weingast (1997) suggest that the political liberalization (including
decentralization) in such established democracies as the United States, Germany, and
Switzerland has promoted their macroeconomic stability, the experiences in many Latin
American countries (e.g., Brazil, Columbia) have shown that political liberalization can
contribute to macroeconomic instability (Burki, Perry, and Dillinger, 1999). Inasmuch as
macroeconomic instability negatively affects growth, a simultaneous promotion of
political and economic reforms may be detrimental to growth. The next section describes
the data set and it sources.
3. The Data and Methodology
6
The paper employs three sets of institutional indicators: the Fraser institute index of
economic freedom, compiled by Gwartney, Lawson and Samida (2000) [GLS]; the
Freedom House [FH] survey of political rights and civil liberties (1998-1999); and the
Polity98 indicators of democracy. The data on the growth rate of the real GDP per capita
and those on the initial per capita real GDP for the twenty countries in the sample (see
table 1 for summary statistics and appendix 1 for the complete list of countries) are
obtained from the World Bank’s Africa Key Indicators Reports from 1971 to 1999, and
are converted into five-year averages over the same period. The data on (total) investment
ratio are obtained from the Penn World Tables, Mark 5.6a, extended with data from the
IFC’s Trends in Private Investment in Developing Countries. The description on other
data follows.
The Economic Freedom Indicators
The GLS data construct a summary index of economic freedom on the basis of
seven (weighted) components: 1. size of government (index of government consumption
as a percentage of total consumption, and of transfers and subsidies as a percentage of
GDP); 2. structure of the economy and use of markets (an index of whether production
and allocation are conducted via governmental and political mandates rather than private
enterprises and markets); 3. monetary policy and price stability (indicator of whether the
country’s money is protected as a store of value and medium of exchange); 4. freedom to
use alternative currencies (an index of freedom of access to alternative currencies); 5.
legal structure and property rights (an indicator of the security of property rights and
viability of contracts); 6. international exchange: freedom to trade with foreigners (an
index of the regulatory environment in the trade sector and the government’s tariff and
non-tariff policy); and 7. freedom of exchange in capital and financial markets (an index
7
of government control and regulation of international capital markets). Note that each of
these components also contains sub-components (see appendix for a complete list of the
sub-categories). Countries are ranked on a scale of 0 to 10, with higher numbers
indicating more economic freedom. It is therefore expected that this economic freedom
index will have a positive relationship with economic growth.
The Political and Civil Liberties Indicators
For the political and civil liberties data, the Freedom House survey rates countries
based on the rights and freedoms enjoyed by individuals in each country and on the basis
of the effect that the political conditions in a country (i.e., war, terrorism) have on
freedom. The FH survey rating is based on two series of checklists. One concerns
political rights and the other civil liberties. Each country or territory is then assigned a
numerical rating for each category; the political rights and civil liberties ratings are
subsequently averaged and used to assign each country and territory to an overall status
of "Free," "Partly Free," or "Not Free." The numerical ratings are based on a scale of 1 to
7 in both instances, with 1 representing the most free and 7 the least free. Because of this
reverse scale rating, it is expected that the relationship between increases in the political
freedom index and economic growth would be negative.
The Democracy Indicator
The democracy indexes come from the Polity98 Project. These data are compiled
by Ted Robert Gurr and Keith Jaggers, and are composed of three indicators: democracy,
autocracy, and durability. The present study includes only the democracy index. A
country’s democracy score indicates the general openness of its political institutions,
whereas its autocracy score indicates the general closedness of its political institutions.
8
The democracy indicator is derived from coding of authority characteristics on the basis
of four criteria, including a) the competitiveness of political participation, or the extent to
which non-elites are able to access institutional structures for political expression; b)
executive recruitment competition, or the extent to which executives are chosen through
competitive elections; c) executive recruitment openness or the opportunity for non-elites
to attain executive office; and d) executive constraints, i.e. the operational (de facto)
independence of the chief executive. Countries are ranked on a 10-point scale, with
higher numbers indicating more openness of political institutions. Thus, the present study
hypothesizes that democracy is a positive determinant of economic growth.
3.1. Methodology
A visual analysis of the data is first conducted. Figure 1 shows a scatter diagram
(with a regression line) relating changes in the index of economic freedom to the growth
rate of GDP. Despite the extent of the variability around it, the regression line adopts a
positive trend, indicating overall, a positive correlation between economic freedom and
economic growth. More liberal economic structures appear to be associated with higher
growth levels. With respect to political rights and civil liberties, the correlation between
each of these indexes and economic growth is negative in figures 2 and 3 (as expected
due to the reverse scale of these indexes), indicating that increased levels of democracy
and civil liberties tend to be associated with increased economic growth for the African
countries in the data.
Pursuant to this visual analysis, econometric estimations are performed to
measure the extent and strength of the correlation between growth and economic and
political freedoms in Africa. Specifically, model (1) is estimated using a fixed-effects
panel data estimation approach. Since this approach pools both cross-section and time
9
series data together, there is reason to suspect that cross-section heteroscedasticity might
be a problem (Greene, 1993), in the sense that residuals associated with the large (in
terms of population) countries in the sample (such as Nigeria, Egypt, South Africa, etc…)
might have larger variances than error terms associated with smaller countries, such as
Benin, Gabon, Ghana and Togo. As is well known, if the model’s error term is not
homoscedastic then OLS estimates will not be efficient, although they may be unbiased
and consistent. Thus, the model was estimated (in Eviews) using a General Least Squares
(GLS) estimator. This method assigns weights to model observations on the basis of
estimated cross-section residual variances. Qualitatively speaking, the resulting estimates
are different from OLS estimates only in that they are more efficient.
Also, the freedom variables are included in the model with a lag, in order to
account for the time lag that will be necessary for a change in institutional policy to affect
economic performance. This method further avoids a potential endogeneity problem that
could develop if economic growth is regressed on the freedom variables
contemporaneously.
4. Estimation Results and Analysis
a. The impacts of economic and political freedoms on growth: a partial
derivative analysis.
The first estimated fixed-effects model is presented in table 2. The model
regresses the growth in real GDP per capita on the initial GDP, the ratio of investment to
the GDP, the (Fraser Institute) freedom summary index, the (Freedom House) civil
liberties index, and the (Polity98) democracy index. All variables have the expected sign
and are highly significant. In particular, initial GDP has a negative sign and is significant
at the 1% level, and the investment ratio has a positive sign and is significant at the 5%
10
level. Further, economic freedom is positively and significantly related to growth. The
civil liberties index is negative and significant (5%), implying in this case (given the
reverse scale of the index) that higher levels of civil liberties are associated with higher
levels of growth, and the democracy index1 is a positive and significant (5%) determinant
of growth. The remaining coefficients are the country-specific constant terms, in
accordance with the fixed-effects approach used in this analysis.
The results in table 2 can be interpreted by means of a simple partial derivative
analysis. They indicate that holding political freedom and the other regressors fixed,
higher economic freedom leads to higher economic growth in Africa. By the same token,
holding economic freedom and the other regressors fixed, higher political freedom is
associated with higher economic growth in the region. This finding does not however
address the issue of the two reforms proceeding simultaneously and the impact of this
simultaneous process on growth. The issue is analyzed in table 3.
b. Assessing the simultaneous effect of political and economic reforms on
growth.
Table 3 addresses the following question: assuming that countries are already
engaged in the process of economic liberalization (for example through structural
adjustment programs as most African countries were by the end of the 1980’s), would a
parallel political liberalization policy (as was the case in many countries in the region in
the 1990’s) derail economic growth in these countries? To capture the simultaneous
impact of economic and political liberalization on growth, an interaction variable is
calculated, which is composed of the economic freedom index and democracy index.
1
The (Freedom House) Political Rights index is excluded from the model because of its high correlation
with the (Polity98) democracy index. Not surprising since the two variables measure similar phenomena.
11
This variable, ECNPOL is calculated as: ECNPOL=FRDSUM*DEMOC for each country.
The remaining variables in the model in table 3 are the economic freedom measure
(FRDSUM), the democracy index (DEMOC), initial GDP (INIGDP) and the investment
ratio (IVGDP). The resulting model can be expressed as:
GDPGR=c0 + c1INIGDP + c2IVGDP + c3(FRDSUM*DEMOC) + c4FRDSUM +
c5DEMOC + µ
Thus, the impact of a one unit change in the economic freedom index on GDP growth is
found as:
d (GDPGR) / d(FRDSUM) = c4 + c3DEMOC
implying that the impact of a change in economic freedom on GDP growth has two
components: its own impact plus an additional source of effect which in turn is a function
of the extent of the democratic freedom in place. Similarly, the impact of a one unit
change in the democracy index on GDP growth is found as:
d (GDPGR) / d(DEMOC) = cc + c3FRDSUM.
Thus, the full impact of a change in democracy on GDP growth is composed of its own
effect and an additional source of impact, which is a function of economic freedom.
Estimation results in table 3 show that the effect of a one unit change in the
economic freedom index on GDP growth for the African sample under study is estimated
as (t-statistics in parenthesis):
d (GDPGR) / d(FRDSUM) = 0.73 + 0.02*DEMOC
(2.64) (2.45)
Further, the effect of one unit change in the democracy index on GDP growth is
estimated to be (t-statistics in parenthesis):
d (GDPGR) / d(DEMOC) = -0.21 + 0.02*FRDSUM
(-1.22) (2.45)
12
The analysis indicates that the impact of an increase in economic freedom on
growth in Africa is not only positive and significant but is moreover significantly
reinforced by an expansion in democratic freedom. However, when the interaction
between political freedom and economic freedom is taken into account, expanding
democratic freedom alone may not have any significant impact on growth (the nonsignificant t-statistic on c5 implies that this coefficient is not statistically different from
zero). The effect of the expansion in democracy on growth becomes positive and
significant however as economic freedom increases.
5. Concluding Remarks
The paper attempts to estimate the impact of political and economic institutional
changes on growth performance in Africa. On the whole, the study finds that promoting
economic freedom, political rights and civil liberty is beneficial for the growth
performance of African countries. This finding of a positive and significant impact of
civil liberty and democracy on economy growth in the specific case of Africa is in
contrast with the findings of at least one previous study (Dawson, 1998), conducted in the
context of a large multi-country, and multi-regional sample.
The policy implications of this study are straightforward and yet insightful. To
achieve higher growth performance African governments ought to expand both economic
freedom and political rights. Furthermore, the institution of a democratic system alone
without increased economic freedom will not have a significant impact on growth.
13
Appendix 1: Definition of variables
GDPGR: Growth rate of real GDP
INIGDP: Initial GDP
IVGDP: Ratio of investment to GDP
FRDSUM: Economic Freedom Summary Index (Fraser Institute)
CVLB: Civil liberties index (Freedom House)
DEMOC: Democracy index (Polity98)
POLRTS: Political rights (democracy) index (Freedom House)
ECNPOL: Interaction variable of the economic and political indexes
Country Specific Constant Terms (Countryi-C):
ALG_: Algeria
BEN_: Benin
BOS_: Botswana
BUR_: Burundi
CAM_: Cameroon
CNG_: Democratic Republic of Congo
CTV_: Cote d’Ivoire (Ivory Coast)
EGY_: Egypt
GHA_: Ghana
KEN_: Kenya
MAD_: Madagascar
MLW_: Malawi
MTS_: Mauritius
MOR_: Morocco
NGR_: Nigeria
SEN_: Senegal
TGO_: Togo
TUN_: Tunisia
ZAM_: Zambia
ZMB_: Zimbabwe
14
Appendix 2: Figures and tables
GDPGR vs. CVLB
GDPGR vs. FRDSUM
10
15
10
GDPGR
GDPGR
5
0
-5
0
-5
-10
-10
2
4
6
8
FRDSUM
GDPGR vs. POLRTS
15
10
5
0
-5
-10
0
2
4
0
2
4
6
8
CVLB
Figure 1: A scatter plot (with regression line)
of the relationship between economic
freedom and growth in Africa
GDPGR
5
6
8
POLRTS
Figure 3: Scatter plot (with regression
line) of the relationship between
democracy and growth in Africa
Figure 2: A scatter plot (with
regression line) of the
relationship between
civil liberties and growth
15
Table 1: Summary statistics on economic and political freedom indicators
Mean
Standard Deviation
GDPGR
IVGDP
FRDSUM
CVLB
DEMOC
POLRTS
INIGDP
0.80
19.60
4.70
4.80
1.40
4.98
759
3.02
6.80
0.94
1.21
7.42
1.64
715
Note: See definition of variables in appendix one.
16
Table 2. Partial impacts of economic and political freedoms on growth.
Variable
Coefficient
t-Stastic
INIGDP
IVGDP
FRDSUM
CVLB
DEMOC
ALG_C
BEN_C
BOS_C
BUR_C
CAM_C
CNG_C
CTV_C
EGY_C
GHA_C
KEN_C
MAD_C
MLW_C
MTS_C
MOR_C
NGR_C
SEN_C
TGO_C
TUN_C
ZAM_C
ZMB_C
-0.002
0.10
0.72
-0.42
0.07
1.36
-1.87
3.37
-0.33
-1.48
-1.43
-1.70
1.51
-1.36
-1.67
-3.57
-1.79
2.61
-0.16
-3.39
-1.48
-3.67
2.14
-3.71
-0.43
(-6.28)***
(2.24)**
(2.63)***
(-2.002)**
(2.17)**
(0.61)
(-0.95)
(1.79)*
(-0.17)
(-0.46)
(-0.51)
(-0.77)
(0.70)
(-0.81)
(-0.75)
(-1.98)**
(-0.91)
(1.30)
(-0.09)
(-1.47)
(-0.84)
(-1.61)
(1.03)
(-2.09)**
(-0.22)
N
R-squared
Adjusted R-square
F-statistic
98
0.78
0.70
10.81
Notes: All variables defined in appendix one. The dependent variable is the five-year average growth rates
of the real per capita GDP from 1971 to 1999. Sample countries enumerated in appendix one.
***, ** and * indicate significance at the 1%, 5%, and 10% respectively.
17
Table 3. The impact of the interaction of economic and political freedoms on growth.
Variable
INIGDP
IVGDP
ECNPOL
FRDSUM
DEMOC
_ALG--C
_BEN--C
_BOS--C
_BUR--C
_CAM--C
_CNG--C
_CTV--C
_EGY--C
_GHA--C
_KEN--C
_MAD--C
_MLW--C
_MTS--C
_MOR--C
_NGR--C
_SEN--C
_TGO--C
_TUN--C
_ZAM--C
_ZMB--C
N
R-squared
Adj. RSqrd
F-statistic
Coefficient t-stat
-0.002 -6.193***
0.10
2.10**
0.02
2.46***
0.73
2.65***
-0.21
-1.22
0.32
0.15
-3.03
-1.73*
2.42
1.40
-1.47
-0.85
-2.55
-0.83
-1.32
-0.44
-2.49
-1.16
0.51
0.26
-2.28
-1.49
-2.72
-1.32
-4.71 -3.06***
-3.12
-1.87*
1.54
0.83
-1.17
-0.70
-4.47
-2.07**
-2.48
-1.59
-4.73
-2.22**
1.32
0.66
-4.70 -2.97***
-1.48
-0.85
98
0.77
0.70
10.33
Notes: All variables defined in appendix one. The dependent variable is the five-year average growth rates
of the real per capita GDP from 1971 to 1999. Sample countries enumerated in appendix one.
***, ** and * indicate significance at the 1%, 5%, and 10% respectively.
18
Appendix 3: Components of the Index of Economic Freedom*
I. Size of Government: Consumption, Transfers, and Subsidies
A. General Government Consumption Expenditures as a Percent of Total
Consumption
B. Transfers and Subsidies as a Percent of GDP
II. Structure of the Economy and Use of Markets (Production and allocation via
governmental and political mandates rather than private enterprises and markets)
A. Government Enterprises and Investment as a Share of the Economy
B. Price Controls: Extent to which Businesses Are Free to Set Their Own Prices
C. Top Marginal Tax Rate (and income threshold at which it applies)
D. The Use of Conscripts to Obtain Military Personnel
III. Monetary Policy and Price Stability (Protection of money as a store of value and
medium of exchange)
A. Average Annual Growth Rate of the Money Supply during the Last Five Years
minus the Growth Rate of Real GDP during the Last Ten Years
B. Standard Deviation of the Annual Inflation Rate during the Last Five Years
C. Annual Inflation Rate during the Most Recent Year
IV. Freedom to Use Alternative Currencies (Freedom of access to alternative currencies)
A. Freedom of Citizens to Own Foreign Currency Bank Accounts Domestically
and Abroad
B. Difference between the Official Exchange Rate and the Black Market Rate
V. Legal Structure and Property Rights (Security of property rights and viability of
contracts)
A. Legal Security of Private Ownership Rights (Risk of confiscation)
B. Viability of Contracts (Risk of contract repudiation by the government)
C. Rule of Law: Legal Institutions Supportive of the Principles of Rule of Law
and Access to a Nondiscriminatory Judiciary
19
VI. International Exchange: Freedom to Trade with Foreigners
A. Taxes on International Trade
i. Revenue from Taxes on International Trade as a Percent of Exports plus
Imports
ii. Mean Tariff Rate
iii. Standard Deviation of Tariff Rates
B. Non-tariff Regulatory Trade Barriers
i. Percent of International Trade Covered by Non-tariff Trade Restraints
ii. Actual Size of Trade Sector Compared to the Expected Size
VII. Freedom of Exchange in Capital and Financial Markets
A. Ownership of Banks: Percent of Deposits Held in Privately Owned Banks
B. Extension of Credit: Percent of Credit Extended to Private Sector
C. Interest Rate Controls and Regulations that Lead to Negative Interest Rates
D. Restrictions on the Freedom of Citizens to Engage in Capital Transactions
with Foreigners
*From: Gwartney, James, Robert Lawson and Dexter Samida (2000)
20
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