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JAD POLICY ON COPYING and DISTRIBUTION of ARTICLES Because a major goal of JAD is to disseminate the research efforts of our authors and to make their work as widely available as possible to policy makers, professors, and students, JAD hereby grants blanket permission to photocopy the material it publishes if that material is to be used for non- profit purposes. This permission covers tables, figures, charts and full-length articles, as well as multiple copies of articles. All copies must indicate the Volume and issue of JAD from which they were copied, plus the cover page and this policy. Persons intending to photocopy JAD material for non-profit use are not required to give notice or remit copying fees. However, please note that permission is still necessary (and fees are usually charged) for JAD material that is to be published elsewhere or used for profit oriented activities by individuals or organizations. The Journal of African Development (JAD) is an official publication of the African Finance and Economics Association in cooperation with New York University. The African Finance and Economics Association and New York University do not assume responsibility for the views expressed in this or subsequent issues of the Journal of African Development. JAD Editorial Policy and Guidelines for the preparation of manuscripts may be found at www.afea.info 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. 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