The Short- and Long-Run Effectsof the 2007–10 Global Financial Crisison Growth in Low-Income Countries

October 18, 2010

Andrew Berg, Catherine Pattillo,

Chris Papageorgiou, Martin Schindler,

Nikola Spatafora, and Hans Weisfeld

IMF

IntroductionKey questions:

How will crisis affect growth in Low-Income Countries (LIC) in the short run?

How will crisis affect growth in LIC in the medium to long run?

Are the effects different in the Middle-Income Countries (MIC)?

How do the effects depend on policies and country characteristics?

Outline of Presentation A few key facts to keep in mind about the

crisis

What can we say about cross-sectional outcomes in 2009?

Can we learn more from a panel, that is, using history as a guide to what happened in 2009 and what will happen in the future?

Medium-run growth: should we fear more persistent output declines that cannot be captured by these approaches, given the historical frequency of structural breaks in the growth process?

Change in Output Growth Rate

-4-2

02

46

P

erce

ntag

e P

oint

s

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Year

Low-Income Countries Middle-Income CountriesAdvanced Economies

Output Growth Rate

-4-2

02

4

P

erce

ntag

e P

oint

s

1995 2000 2005 2010 2015

Year

Low-Income Countries Middle-Income CountriesAdvanced Economies

Key Fact: Severity of 2009 Recession

34

76

95

36

17

5

16

2

115

2020

4060

8010

0

Per

cent

age

of c

ount

ries

by g

roup

Of all years

Worst 20% Worst 20%-40% Middle Best 20%-40% Best 20%

Low-Income Countries Middle-Income CountriesAdvanced Economies

Key Fact: Output SynchronizationAverage Bilateral Correlations of Real GDP per Capita Growth

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

-0.2

0

0.2

0.4

0.6

0.8

1

Advanced LIC MIC

Change in Growth Rate of External Demand

Key Fact: Collapse in External Demand

-4-2

02

46

P

erce

ntag

e P

oint

s

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Year

Low-Income Countries Middle-Income CountriesAdvanced Economies

Change in Growth Rate of Terms of Trade (non-fuel-exporters)

Little Change in the Terms of Trade

-15

-10

-50

510

P

erce

ntag

e P

oint

s

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Year

Low-Income Countries Middle-Income CountriesAdvanced Economies

Cross-Country Analysis:Output and External Demand, 2007-09

-30

-20

-10

010

Cha

nge

in th

e G

row

th o

f per

Cap

ita G

DP

-30 -20 -10 0 10Change in the Growth of external Demand

Cross-Country Analysis:Output and Terms of Trade, 2007-09

-30

-20

-10

010

Cha

nge

in th

e G

row

th o

f per

Cap

ita G

DP

-100 0 100 200Change in the Growth of Terms of Trade

Cross-Country OLS Regression: BaselineOn LHS: Output Growth Rate.

On RHS: Three key external shock variables (Change in External Demand, in Terms of Trade, and in lagged FDI / GDP) and their lags

Sample: 49 LIC, annual data. Key findings:

A larger decline in external demand growth is significantly associated with a larger growth decline.

A larger decline in FDI/GDP is significantly associated with a larger growth decline.

No significant impact from changes in the terms of trade.

Cross-Country Analysis: Role of PolicyAssociated with smaller growth decline:

Higher reserves / (short-term liabilities + current account deficit)

Associated with a larger growth decline: Larger credit boom in preceding years. More flexible exchange rate regime. Higher initial level of FDI. Higher per capita income. Smaller share of commodities exports in GDP.

Other variables (incl. initial fiscal balance, fiscal debt, current account balance, remittances, openness) not significantly associated with magnitude of growth decline.

Panel AnalysisNext step: panel GMM regression, using

annual data.

On LHS: Output Growth Rate.

On RHS: Change in External Demand, in Terms of Trade, and in lagged FDI / GDP, and their lags.

Other controls: country- and year-specific fixed effects; lagged output growth rate.

Panel GMM Analysis:Baseline Specification for Output Growth

 All Non-fuel Exporters LICs MICs

Lagged Growth 0.229*** 0.190** 0.386***  (0.064) (0.086) (0.055)Growth in Terms of Trade 0.009 0.008 0.005  (0.014) (0.014) (0.028)Lagged Growth in Terms of Trade 0.010 0.007 0.002  (0.012) (0.011) (0.030)Growth in External Demand 1.072*** 0.352** 0.960***  (0.151) (0.157) (0.204)Lagged Growth in External Demand -0.104 -0.034 -0.257  (0.126) (0.156) (0.183)Change in (FDI / GDP) 0.082** 0.021 0.112**  (0.037) (0.041) (0.046)Lagged Change in (FDI / GDP) 0.140*** 0.056 0.190***  (0.029) (0.046) (0.047)       Observations 1624 853 771Number of Countries 89 47 42Note: Regressions include a full set of country- and year-specific fixed effects. Robust standard errors in parentheses. ***, **, and * denote statistical significance at, respectively, the 1 percent, 5 percent, and 10 percent level.

Panel Analysis:Fitting the 2007-09 Output Decline

Actual vs. Predicted Change in Output Growth, 2007-09

-30 -25 -20 -15 -10 -5 0

-30

-25

-20

-15

-10

-5

0

5

LIC

MIC

Predicted Change in Growth: 2009-2007

Act

ual C

hang

e in

Gro

wth

: 200

9 -2

007

Panel Analysis: Growthand External Demand, 2007-09

BelarusBelarusBelarusBelarusBelarusBelarusBelarusBelarusBelarusBelarusBelarusBelarusBelarusBelarusBelarusBelarusBelarusBelarusBelarusBelarus

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SenegalSenegalSenegalSenegalSenegalSenegalSenegalSenegalSenegalSenegalSenegalSenegalSenegalSenegalSenegalSenegalSenegalSenegalSenegalSenegal

GeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgiaGeorgia

UzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistanUzbekistan

-30

-20

-10

010

Orth

ogon

aliz

ed G

row

th D

iffer

ence

-15 -10 -5 0

External Demand Growth: 2009-2007 Difference

MIC LIC

The Role of PolicyExamine the role of policy through alternative

specifications, where impact of shocks to external demand, terms of trade, or capital flows is interacted with:

Exchange Rate Regime Initial Reserve Levels Initial Deficits or Debt Levels Indicators of Structural Reform & Flexibility (external

trade, labor & product markets, financial markets) Institutional Quality

One robust result: higher initial reserves buffer impact of large negative shocks. Other results inconclusive.

Growth Forecasts: Average for 2010–2011, Relative to 2009 Growth

  All Non–fuel Exporters LICs MICs

WEO Forecast Mean Growth Difference 3.7 2.0 5.8Model Forecast Mean Growth Difference

5.2 1.4 4.9

Mean Contribution of Change In:Lagged Growth -0.5 -0.2 -1.2

Terms of Trade 0.0 0.0 0.0

Lagged Terms of Trade 0.0 0.0 0.0

External Demand 5.5 1.6 5.5

Lagged External Demand 0.2 0.0 0.5

(FDI / GDP) 0.1 0.0 0.2

Lagged (FDI / GDP) -0.1 -0.1 0.0

Medium- to Long-Run Effects Low-income countries as a group have

enjoyed relatively rapid growth in recent years. Since 1995, for example, sub-Saharan Africa has grown faster than developed countries, after many years of poor average performance.

If the current shock has longer-run implications (that is, if it knocks countries off a track of solid medium-long-term growth), then it will be a much greater disaster.

History Has Not Been Kind In principle, a temporary negative shock to

external demand or the terms of trade in a standard neoclassical growth model would be followed by a reasonably quick reversion.

However, history is not optimistic that LIC can uniformly escape global shocks without absorbing long-lasting damages both on growth and welfare.

There is also an emerging empirical literature that points to growth nonlinearities, growth accelerations, and growth decelerations.

So, important to consider not only the short-run implications of the crisis and policy responses, but also the risks to medium-run growth and how to sustain it.

1. Impulse Response: We employ impulse response function analysis as in Cerra and Saxena (2008)

Impulse response of output loss in LIC to TOT shock

Impulse response of output loss in LIC to ED shock

-4-3

-2-1

0

perc

ent d

evia

tion

from

bas

elin

e tre

nd

0 2 4 6 8 10

Years after the shock

Note 1: Number of countries: 77; Number of observations: 3648Note 2: Crisis episode was calculated using left tail of the distributionNote 3: Macroeconomics Studies Division IMF

LICsResponse of Change in Loss Output to Terms of trade

-8-6

-4-2

0

perc

ent d

evia

tion

from

bas

elin

e tre

nd

0 2 4 6 8 10

Years after the shock

Note 1: Number of countries: 77; Number of observations: 3648Note 2: Crisis episode was calculated using left tail of the distributionNote 3: Macroeconomics Studies Division IMF

LICsResponse of Change in Loss Output to External Demand

2. Growth regressions: A second exercise employs 5-year panel growth regressions as an alternative approach to investigating the impact of TOT, ED and FDI shocks on medium-term per capita GDP growth.

GDP(growth) = a0 + a1lagGDP(growth) + a2TOT+a3ED+a4FDI+η

Panel GMM w/ time effectsEntire Time Period Before 1990 After 1990

VARIABLES All PRGF-NF NPRGF-NF All PRGF-NF NPRGF-NF All PRGF-NF NPRGF-NF

Lagged Growth -0.209*** -0.167** -0.237** -0.577*** -0.487*** -0.662*** -0.292*** -0.287*** -0.261***(0.066) (0.077) (0.095) (0.092) (0.096) (0.110) (0.063) (0.080) (0.083)

Growth in Terms of Trade 0.123*** 0.115* 0.111** 0.031 0.030 0.023 0.156** 0.131* 0.182***(0.047) (0.064) (0.053) (0.028) (0.046) (0.028) (0.063) (0.077) (0.066)

Growth in External Demand 2.603*** 1.960*** 3.419*** 1.332** 0.617 2.599** 1.727*** 1.665* 1.769**(0.606) (0.736) (0.786) (0.609) (0.599) (1.135) (0.666) (0.938) (0.706)

Lagged Change in (FDI / GDP) 0.631*** 0.221 1.010*** 0.599 -0.404 1.773*** 0.783*** 0.517* 0.953***(0.187) (0.222) (0.270) (0.633) (0.732) (0.528) (0.243) (0.305) (0.319)

Observations 529 281 248 181 92 89 348 189 159Number of country_code 88 48 40 86 47 39 88 48 40Robust standard errors in parentheses*** p<0.01, ** p<0.05, * p<0.1

3a. Growth breaks: Use Berg, Ostry and Zettelmeyer (2010) to identify growth decelerations (sustained periods of slow growth) in LIC, and trace TOT and ED shocks before and after.

-10

-50

510

Gro

wth

(%)

-5 -4 -3 -2 -1 0 1 2 3 4 5Growth Downturns

GDP per Capita Terms-of-trade

Note1: Number of countries on which the average is based are 15Note 2: Number of observations on which the average is based are 19Note 3: Macroeconomics Studies Division IMF

SSAGDP per Capita and Terms-of-trade (Growth Rates)

-10

-50

510

Gro

wth

(%)

-5 -4 -3 -2 -1 0 1 2 3 4 5Growth Downturns

GDP per Capita External demand

Note1: Number of countries on which the average is based are 13Note 2: Number of observations on which the average is based are 17Note 3: Macroeconomics Studies Division IMF

SSAGDP per Capita and External demand (Growth Rates)

Source: IMF staff calculations.Note: The left panel plot the number of GDP growth downbreaks in a large sample of low-income countries (excluding transition economies) during the periods leading up to, and following, a large persistent terms of trade shock (year t+0 on the horizontal axis). A large persistent TOT shock is defined as the worst 10 percent of the distribution of all TOT shocks, measured as the difference of the average 3 year TOT growth before and after period t. The right panel is the same, except that the shock is to external demand, measured as partner country real growth weighted by export shares.

05

10Nu

mbe

r of G

DP gr

owth

dow

nbre

aks

t-5 t-4 t-3 t-2 t-1 t+0 t+1 t+2 t+3 t+4 t+5

Growth downbreaks Vs. Persistent Terms-of-Trade shock

Years of shock

05

10Nu

mbe

r of G

DP gr

owth

dow

nbre

aks

t-5 t-4 t-3 t-2 t-1 t+0 t+1 t+2 t+3 t+4 t+5

Growth downbreaks Vs. Persistent External demand shock

Years of shock

3b. Growth breaks: GDP growth decelerations (sustained periods of slow growth) vs. large permanent TOT and ED shocks.

Message from MR-LR analysis Since the current crisis affected LIC

primarily through a shock to External Demand rather than the Terms of Trade ...

… this implies a low probability that many LIC will see an end to the period of strong growth they enjoyed prior to the crisis.

Still, shocks to External Demand are often associated with persistent output losses …

… which highlights the need for vigilance and prudent policy to protect pre-crisis growth trends.

Thank You