HKS Center for International Development

Countries that specialize in commodities have in recent years been hit by high volatility in world prices for their exports. This paper suggests four ways that commodity-exporters can make themselves less vulnerable.

(1) Option contracts can be used to hedge against short-term declines in the commodity price without giving up the upside, as Mexico has shown.

(2) Commodity-linked bonds can hedge longer-term risk, and often have a natural ultimate counter-party in multinational corporations that depend on the commodity as an input.

(3) The well-documented pro-cyclicality of fiscal policy among commodity exporters can be reduced by insulating official forecasters against an optimism bias, as Chile has shown.

(4) Monetary policy can be made automatically more counter-cyclical, judged by the criterion of currency appreciation in reaction to positive terms-of-trade shocks, under either of two regimes: peggers can add the export commodity to a currency basket (CCB, for “Currency-plus-Commodity Basket”) and others can target Nominal Income instead of the CPI.

To update a famous old statistic: a political leader in a developing country is twice as likely to lose office in the 6 months following a currency crash as otherwise. This difference, which is highly significant statistically, holds regardless whether the devaluation takes place in the context of an IMF program. Why are devaluations so costly? Many of the currency crises of the last ten years have been associated with output loss. Is this, as alleged, because of excessive reliance on raising the interest rate as a policy response? More likely it is because of contractionary effects of devaluation. There are various possible contractionary effects of devaluation, but it is appropriate that the balance sheet effect receives the most emphasis. Passthrough from exchange rate changes to import prices in developing countries is not the problem: this coefficient fell in the 1990s, as a look at some narrowly defined products shows. Rather, balance sheets are the problem. How can countries mitigate the fall in output resulting from the balance sheet effect in crises? In the shorter term, adjusting promptly after inflows cease is better than procrastinating by shifting to short-term dollar debt, which raises the costliness of the devaluation when it finally comes. In the longer term, greater openness to trade reduces vulnerability to both sudden stops and currency crashes.

When local cost discovery generates knowledge spillovers, specialization patterns become partly indeterminate and the mix of goods that a country produces may have important implications for economic growth. We demonstrate this proposition formally and adduce some empirical support for it. We construct an index of the "income level of a country's exports," document its properties, and show that it predicts subsequent economic growth.

This paper argues that current account statistics may provide a poor indication for the real evolution of a country’s net foreign assets. This may be due to a series of factors including the mismeasurement of FDI, unreported trade of insurance or liquidity services and debt relief. Because of these problems we suggest estimating net foreign assets by capitalizing the net investment income and then estimating the current account from the changes in this stock of foreign assets. We call dark matter the difference between our measure of net foreign assets and that portrayed by official statistics. We find dark matter to be important for many countries and that it relates to FDI flows, domestic volatility, and debt relief. We also find that, once dark matter is taken into account, global net asset positions appear to be relatively stable. In particular, the exports of dark matter of the US appear to be fairly steady and large enough to keep the US net asset position stable, casting doubts on the need for a major adjustment of the dollar or a large rebalancing of the global economy.

Revised edition. When local cost discovery generates knowledge spillovers, specialization patterns become partly indeterminate and the mix of goods that a country produces may have important implications for economic growth. We demonstrate this proposition formally and adduce some empirical support for it. We construct an index of the "income level of a country's exports," document its properties, and show that it predicts subsequent economic growth.

There are two widely-held views on economic growth: 1) it is a natural outcome of getting ‘the basics’ right-- international integration, macroeconomic stability, and contract enforcement; and 2) it is hard, requiring a complete set of first, second, and third generation reforms that have little payoff until they are all implemented. Yet the evidence shows that growth accelerations do not naturally arise from the Washington Consensus basics, nor do they require extensive reform. Instead, accelerations are triggered by a more effective focus on identifying and removing the binding constraints to growth as they arise. This shifts the focus from creating a laundry list of reforms to using diagnostic signals to identify what particular constraints are holding back growth in a particular country at a particular time. Furthermore, growth involves not only coping with government failures, but also eliminating market failures. Therefore it is not just government sins of commission that drive down growth, it is also sins of omission: things that governments are not doing to overcome market failures. In many instances, there are ad hoc solutions that get the job done. Identifying and implementing such solutions requires a dynamic policy process where problems are identified and addressed, overcoming market failures while containing government failures.

China’s economic and social achievements since the beginning of reform and opening are unprecedented in global history. Managing the growth process in this continuously changing environment has required great skill and the use of unconventional economic policy. Now China has entered a new era in its development process with a set of challenges largely different from those of the recent past. Some problems - such as growing internal and external structural imbalances, increasing income and regional inequality – have arisen from, or been exacerbated by, the very pattern and success of high growth since reforms began. Others are newly posed by rapid changes in the global economy. These challenges can best be tackled in an integrated and coordinated fashion. This report, supported by the China Economic Research and Advisory Programme (CERAP), identifies the primary challenges facing China today and presents options for meeting them.

In this paper we examine the product space and its consequences for the process of structural transformation. We argue that the assets and capabilities needed to produce one good are imperfect substitutes for those needed to produce other goods, but the degree of asset specificity varies widely. Given this, the speed of structural transformation will depend on the density of the product space near the area where each country has developed its comparative advantage. While this space is traditionally assumed to be smooth and continuous, we find that in fact it is very heterogeneous, with some areas being very dense and others quite sparse. We develop a measure of revealed proximity between products using comparative advantage in order to map this space, and then show that its heterogeneity is not without consequence. The speed at which countries can transform their productive structure and upgrade their exports depends on having a path to nearby goods that are increasingly of higher value.

This paper explores export performance in South Africa over the past 50 years, and concludes that a lagging process of structural transformation is part of the explanation for stagnant exports per capita. Slow structural transformation in South Africa is found to be a consequence of the peripheral nature of South Africa’s productive capabilities. We apply new tools to evaluate South Africa’s future prospects for structural transformation, as well as to explore the sectoral priorities of the DTI’s draft industrial strategy. We then discuss policy conclusions, advocating an ‘open-architecture’ industrial policy where the methods applied herein are but one tool to screen private sector requests for sector-specific coordination and public goods.

The South African economy has been doing well. Capital inflows and the rand have been strong, growth was high in 2005, the budget is relatively healthy, and inflation rates and interest rates are low. As democracy continues to consolidate, there are plenty of grounds for optimism. Is the job done, or do these achievements open the door to new challenges? What are the risks in the horizon? And how does the government’s ASGI-SA strategy deal with the challenges? This report provides four areas of analysis: an analysis of the current account, the consistency of the ASGI-SA program, the benefits of the current fiscal-macro policy mix and the choice of exchange rate regime. We suggest that ASGI-SA relies too heavily on capital accumulation, in a way that other growth accelerations have not. In addition there are grounds for doubt whether the required jump in investment will be forthcoming, and for worry by how much it would deteriorate South Africa's current account deficit. South Africa would suffer less from a sudden stop of capital inflows than would other emerging economies, particularly because most of the inflows do not take the form of debt denominated in foreign currency. Nevertheless, the already-large current account deficit is worrisome. South Africa is still exposed to a possible a sudden stop, particularly one triggered by a reversal of the global climate for mineral commodities and emerging markets generally. We offer some proposals for reducing this vulnerability. They include avoidance of pro-cyclical fiscal policy and active intervention by the monetary authorities to build up reserves and dampen real exchange rate appreciations.

We study episodes where economic growth decelerates to negative rates. While the majority of these episodes are of short duration, a substantial fraction last for a longer period of time than can be explained as the result of business-cycle dynamics. The duration, depth and associated output loss of these episodes differs dramatically across regions. We investigate the factors associated with the entry of countries into these episodes as well as their duration. We find that while countries fall into crises for multiple reasons, including wars, export collapses, sudden stops and political transitions, most of these variables do not help predict the duration of crises episodes. In contrast, we find that a measure of the density of a country's export product space is significantly associated with lower crisis duration. We also find that unconditional and conditional hazard rates are decreasing in time, a fact that is consistent with either strong shocks to fundamentals or with models of poverty traps.

This paper clarifies how dark matter changes our assessment of the US external imbalance. Dark matter assets are defined as the capitalized value of the return privilege obtained by US assets. Because this return privilege has been steady over recent decades, it is likely to persist in the future or even to increase, as it becomes leveraged by an increasingly globalized world. Once this is included in future projections of US current accounts, the US external position looks much more balanced than depicted in official statistics.

This paper explores the role that uncertainty plays in the emergence of new products or services for export in developing countries. Using a comparative case study method, I explore the degree to which those entrepreneurs who discovered new export activities faced uncertainty, and what the nature of this uncertainty was. I then document how this uncertainty, when present, was resolved, and how this affected subsequent diffusion of the newly discovered activity. The cases suggest two important dimensions of uncertainty in the emergence of new export activities: productivity characteristics and demand characteristics. A new activity could feature one, both, or neither types of uncertainty. The reasons for lower inherent uncertainty in these cases suggest a new theory of product similarity that is heterogeneous, multi-dimensional, and operating at a highly disaggregated level. Furthermore, the degree of uncertainty has implications for the expected ‘triggers’ of discovery, and these are born out in the cases. Finally, when uncertainty was present, its resolution often provided significant benefits to subsequent entrants, and the manner in which high uncertainty was overcome suggests potential avenues for policy.

This paper is an econometric investigation of the determinants of the real value of the South African rand over the period 1984-2006. The results show a relatively good fit. As always with exchange rate equations, there is substantial weight on the lagged exchange rate, which can be attributed to a momentum component. Nevertheless, economic fundamentals are significant and important. This is especially true of an index of the real prices of South African mineral commodities, which even drives out real income as a significant determinant. An implication is that the 2003-2006 real appreciation of the rand can be attributed to Dutch Disease. In other respects, the rand behaves like currencies of industrialized countries with well-developed financial markets. In particular, high South African interest rates raise international demand for the rand and lead to real appreciation, once one also controls for a forward-looking measure of expected inflation and a measure of default risk or country risk. It is in the latter respects, in particular, that the paper purports to improve on earlier studies of the rand.

This paper establishes a robust stylized fact: changes in the revealed comparative advantage of nations are governed by the pattern of relatedness of products at the global level. As countries change their export mix, there is a strong tendency to move towards related goods rather than to goods that are farther away. The pattern of relatedness of products is only very partially explained by similarity in broad factor or technological intensities, suggesting that the relevant determinants are much more product-specific. Moreover, the pattern of relatedness of products exhibits very strong heterogeneity: there are parts of this ‘product space’ that are dense while others are sparse. This implies that countries that are specialized in a dense part of the product space have an easier time at changing their revealed comparative advantage than countries that are specialized in more disconnected products.

We study the effect of entrepreneurial training on enterprise outcomes, in particular whether business training for (potential) entrepreneurs of small- and medium scale enterprises can lead to an increase in the number of business start-ups or an expansion in the size of existing businesses. We study this question by analyzing the results of business training programs that an NGO held in Central America between 2002 and 2005. To deal with endogenous selection into the training program, we exploit the fact that a fixed number of applicants are taken into the training program based on a pre-training score, which creates a discontinuity around which we can compare accepted and rejected applicants and estimate the effect of training with a regression-discontinuity design. We find that receiving business training significantly increases the probability that an applicant to the workshop starts a business or expands an existing business. Thus, entrepreneurial activity such as starting and expanding businesses can be fostered by training. Exploiting the fact that in the last stage the most successful participants of the program receive substantial monetary prizes (between US$ 6,000 and 15,000) we can also provide some experimental evidence that suggests the presence of financial constraints. Finally, we investigate gender differences, and find that females experience a much larger increase in the probability of starting a business if they win the monetary prize than men, suggesting financial constraints may be significantly larger for female entrepreneurs.

The euro has arisen as a credible eventual competitor to the dollar as leading international currency, much as the dollar rose to challenge the pound 70 years ago. This paper uses econometrically-estimated determinants of the shares of major currencies in the reserve holdings of the world’s central banks. Significant factors include: size of the home country, rate of return, and liquidity in the relevant home financial center (as measured by the turnover in its foreign exchange market). There is a tipping phenomenon, but changes are felt only with a long lag (we estimate a weight on the preceding year’s currency share around .9). The equation correctly predicts out-of-sample a (small) narrowing in the gap between the dollar and euro over the period 1999-2007. This paper updates calculations regarding possible scenarios for the future. We exclude the scenario where the United Kingdom joins euroland. But we do take into account of the fact that London has nonetheless become the de facto financial center of the euro, more so than Frankfurt. We also assume that the dollar continues in the future to depreciate at the trend rate that it has shown on average over the last 20 years. The conclusion is that the euro may surpass the dollar as leading international reserve currency as early as 2015.

The paper offers a new approach to estimate countries' de facto exchange rate regimes, a synthesis of two techniques. One is a technique that the authors have used in the past to estimate implicit de facto weights when the hypothesis is a basket peg with little flexibility. The second is a technique used by others to estimate the de facto degree of exchange rate flexibility when the hypothesis is an anchor to the dollar or some other single major currency, but with a possibly-substantial degree of flexibility around that anchor. Since many currencies today follow variants of Band-Basket-Crawl, it is important to have available a technique that can cover both dimensions, inferring weights and inferring flexibility. We try out the technique on twenty-some currencies, over the period 1980-2007. Most are currencies that have officially used baskets as anchors for at least part of this sample period. But a few are known floaters or known simple peggers. In general the synthesis technique seems to work as it should.

Beneficiation, moving downstream, and promoting greater value added in natural resources are very common policy initiatives to stimulate new export sectors in developing countries, largely based on the premise that this is a natural and logical path for structural transformation. But upon closer examination, we find that very few countries that export raw materials also export their processed forms, or transition to greater processing. The quantitative analysis finds that broad factor intensities do a much better job of identifying patterns of production and structural transformation than forward linkages, which have an insignificant impact despite the fact that our data is biased against finding significant effects of factor intensities and towards finding significant effects of forward linkages. Moreover, the explanatory power of forward linkages is even smaller in sectors with high transport costs, and in sectors classified as primary products or raw materials, which are the most common targets of such policies. Finally, the results are the same even when only considering developed countries, meaning that colonial legacy inhibiting transitions to natural resource processing are not to blame. These results suggest that policies to promote greater downstream processing as an export promotion policy are misguided. Structural transformation favors sectors with similar technological requirements, factor intensities, and other requisite capabilities, not products connected in production chains. There is no reason for countries like South Africa to focus attention on beneficiation at the expense of policies that would allow other export sectors to emerge. This makes no sense conceptually, and is completely inconsistent with international experience. Quite simply, beneficiation is a bad policy paradigm.

The main purpose of industrial policy is to speed up the process of structural change towards higher productivity activities. This paper builds on our earlier writings to present an overall design for the conduct of industrial policy in a low- to middle-income country. It is stimulated by the specific problems faced by South Africa and by our discussions with business and government officials in that country. We present specific recommendations for the South African government in the penultimate section of the paper.