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Political Ambiguity and Economic Growth: The MENA Countries by Juliane Brach and Willem Spanjers

Political Ambiguity and Economic Growth: The MENA Countries by Juliane Brach and Willem Spanjers (Kingston University and Rimini Centre for Economic Analysis) 14 th May 2013 University of Bologna at Rimini Rimini, Italy. Political Ambiguity and Growth: the MENA Countries. 2. Contents:

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Political Ambiguity and Economic Growth: The MENA Countries by Juliane Brach and Willem Spanjers

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  1. Political Ambiguity and Economic Growth: The MENA Countries by Juliane Brach and Willem Spanjers (Kingston University andRimini Centre for Economic Analysis) 14th May 2013 University of Bologna at Rimini Rimini, Italy

  2. Political Ambiguity and Growth: the MENA Countries 2 Contents: • Introduction • Ambiguity • An Example of Modelling Ambiguity • Decision Making under Ambiguity • Basic Growth Strategies • The Model • The Data • Empirical Results • Concluding Remarks

  3. Political Ambiguity and Growth: the MENA Countries 3 1. Introduction Stylized facts: • Some MENA countries consistently grow below their potential. Basic question: • May this be due to the impact of ambiguity and fear? Answer: • Possibly yes. • Ambiguity with respect to: - the internal political situation (e.g. succession) - the external political situation (e.g. conflict).

  4. Political Ambiguity and Growth: the MENA Countries 4 2. Ambiguity • Keynes (1937) gives a description of ambiguity: “By ‘uncertain’ knowledge, let me explain, I do not mean merely to distinguish what is known for certain from what is only probable. The game of roulette is not subject, in this sense, to uncertainty [...]. The sense in which I am using the term is that [...] there is no scientific basis on which to form any calculable probability whatever. We simply do not know.” [pp. 113-114]

  5. Political Ambiguity and Growth: the MENA Countries 5 To Keynes, this is not without consequences for economic theory: “[T]he fact that our knowledge of the future is fluctuating, vague and uncertain, renders wealth a peculiarly unsuitable subject for the methods of the classical economic theory. This theory might work very well in a world in which economic goods are necessarily consumed within a short interval of their being produced. But it requires, I suggest, considerable amendment if it is to be applied to a world in which the accumulation of wealth for an indefinitely postponed future is an important factor; and the greater the proportionate part played by such wealth accumulation the more essential does such amendment become.”[p. 113]

  6. Political Ambiguity and Growth: the MENA Countries 6 He than continues to discuss its implications: “Now a practical theory of the future [...] has certain marked characteristics. In particular, being based on so flimsy a foundation, it is subject to sudden and violent changes. The practise of calmness and immobility, of certainty and security, suddenly breaks down. New fears and hopes will, without warning, take charge of human conduct. The forces of disillusion may suddenly impose a new conventional basis of valuation. All these pretty, polite techniques, made for a well-panelled board room and a nicely regulated market are liable to collapse. At all times vague panic fears and equally vague and unreasoned hopes are not really lulled, and lie but a little way below the surface.”[pp. 114-115]

  7. Political Ambiguity and Growth: the MENA Countries 7 The Modelling of Ambiguity • Belief functions - Dempster (1968) and Shafer (1976)- Example by Mukerjee (ET 1997)- E(llsberg)-capacities as in Eichberger and Kelsey (1999). • Multiple Prior Approach - in the tradition of Gilboa and Schmeidler (1989). • Choquet Expected Utility - in the tradition of Schmeidler (1982/1989) - Neo-additive capacities as in Chateauneuf et al. (2007).

  8. Political Ambiguity and Growth: the MENA Countries 8 3. An Example of Modelling Ambiguity • Consider a US investor holding Greek assets. • There are four relevant potential situations θєΘrelevant for his payouts:

  9. Political Ambiguity and Growth: the MENA Countries 9 • The asset price and the exchange rate are determined by the state of the economy, ωєΩ, where:

  10. Political Ambiguity and Growth: the MENA Countries 10 • The investors know the probabilities with which the various states of the economy will occur, but can not always predict their effects on the asset market and the foreign exchange market:

  11. Political Ambiguity and Growth: the MENA Countries 11 • The minimum probability of an event T⊆Θ is v(T) := Σω: Γ(ω) ⊆T P({ω}) • The function v is not additive because: v({θ2}) = P(∅) = 0 v({θ3}) = P({ω2}) = 0.4 but v({θ2,θ3}) = P(∅) + P({ω2}) + P({ω3}) = 0 + 0.4 + 0.1 = 0.5.

  12. Political Ambiguity and Growth: the MENA Countries 12 • Now suppose the portfolio generates the following payouts for the situation θєΘ in the asset and foreign exchange markets: • A cautious “pessimistic” decision investor assigns to state ω the worst outcome that may occur in this state. • An exuberant “optimist” decision maker assigns to the state ω the best outcome that may occur in this state.

  13. Political Ambiguity and Growth: the MENA Countries 13 • For a pessimistic decision maker, the outcomes assigned to the states of nature ωєΩ are:

  14. Political Ambiguity and Growth: the MENA Countries 14 The expected payout for this pessimistic investor is now obtained as: P({ω1}) f(θ1)+ P({ω2}) f(θ3) + P({ω4}) f(θ4)+ P({ω3}) min{f(θ2), f(θ3)} + P({ω5}) minθєΘf(θ) = 0.2 f(θ1)+ 0.4 f(θ3) + 0.2 f(θ4)+ 0.1 min{f(θ2), f(θ3)} + 0.1 minθєΘf(θ).

  15. Political Ambiguity and Growth: the MENA Countries 15 • Consider the payout profiles g:= (5, 10, 3, 0) and h := (5, 0, 10, 3). • Now we have and implied probabilities over Θ

  16. Political Ambiguity and Growth: the MENA Countries 16 • So we find that the implied probability weighting over the market states Θ depends on the ranking of the payouts over the market states. • A situation where the probabilities assigned to the different outcome would normally be referred to as “superstition”. • It would also run counter to separating the beliefs over which outcomes are obtained from the evaluation of the specific outcomes. • But the “minimum probability function” (belief function) vis independent of the outcomes!

  17. Political Ambiguity and Growth: the MENA Countries 17 Simple Capacity • Consider the state space S:={1,...,n}, a probability distribution π and a coefficient γє [0,1]. • Now the capacity v is a simple capacity if v(E) := γπ(E)if E ≠ S 1 if E = S. • Let (t1,...,tn) be a permutation of S such that f(t1) ≤ ... ≤ f(tn), so minsєSf(s) = f(t1). • Applying the above procedure now gives γEπ{f(s)} + (1 - γ) minsєSf(s).

  18. Political Ambiguity and Growth: the MENA Countries 18 4. Decision Making under Ambigiuty Let (π1,..., πS) denote the probability estimate γ ∊ [0,1] denote the level of confidence in the probability estimate β ∊ [0,1] denote the level of optimism/ pessimism of the decision maker. Now the utility of the decision maker is: U(x1,...,xS ; π1,..., πS; γ; β) := γ𝔼{u(x)} + (1 – γ)∙β∙max s∊{1,...,S}u(xs) + (1 – γ)∙(1-β)∙min s∊{1,...,S}u(xs).

  19. Political Ambiguity and Growth: the MENA Countries 19 5. Basic Growth Strategies Countries face a trade-off between: • a medium technology development strategy characterized by agglomeration effects and overall increasing returns scale (“urban sectors”) and • a low technology development strategy characterized by overall decreasing returns to scale and a tendency to geographical dispersion of economic activity (“rural sectors”).

  20. Political Ambiguity and Growth: the MENA Countries 20 Low technology development strategy: - decreasing returns to scale - low requirements on: - infrastructure - the education and judicial systems - regional and redistributive policies - openness to international trade - low vulnerability to financial and political shocks. - low contribution f(x) to rate of growth where x denotes the available amount of resources for private and public investment.

  21. Political Ambiguity and Growth: the MENA Countries 21 Medium technology development strategy: - increasing overall returns to scale - high requirements on: - infrastructure - the education and judicial systems - regional and redistributive policies - openness to international trade - high vulnerability to financial and political shocks - high contribution g(y) to the rate of growth where y denotes the available amount resources for private and public investment.

  22. Political Ambiguity and Growth: the MENA Countries 22 6. The Model • Each country has fixed resources, to invest in: - low technology sectors - medium technology sectors - the oil sector. • The growth created by further resources invested: - in low technology decreases due to decreasing returns to scale. - in medium technology decreases due to restrictions on the absorbing capacity of sectors. - in the oil sector is constant until the maximum absorbing capacity is reached.

  23. Political Ambiguity and Growth: the MENA Countries 23 • Low technology sectors: - low expected growth: f(x), f ’(x) > 0, f ’’(x) < 0 - worst case f min(x) not too bad. • Medium technology sectors: - high expected growth: g(y), g’(y) > 0, g’’(y) < 0 - worst case gmin(y) very bad; for all attainable x and y: f min(x) > gmin(y) andf min ’(x) > gmin ’(y) . • Oil sector: - expected growth: h(z), h’(z) = hconst for z ≤ zmax - worst case hmin ’(z) = hconst.

  24. Political Ambiguity and Growth: the MENA Countries 24 Case: x + y = c growth g’(y) f ’(x) • f min’(x) x = 0 gmin’(y) y = 0 c y* x*

  25. Political Ambiguity and Growth: the MENA Countries 25 Case: x + y = c growth γ∙g’(y) + (1-γ)∙gmin ’(y) • γ∙f ’(x) + (1-γ)∙fmin ’(x) • f min ’(x) gmin ’(y) y = 0 x = 0 c y*(γ) x*(γ)

  26. Political Ambiguity and Growth: the MENA Countries 26 Case: x + y + z = c growth g’(y) f ’(x) h’(z) = hmin ’(z) • • f min ’(x) gmin ’(y) c z* y* x*

  27. Political Ambiguity and Growth: the MENA Countries 27 Case: x + y + z = c growth γ∙g’(y) + (1-γ)∙gmin ’(y) h’(z) = γ∙h’(z) + (1-γ)∙hmin ’(z) γ∙f ’(x) + (1-γ)∙fmin ’(x) • • • • c z*(γ) x*(γ) y*(γ)

  28. Political Ambiguity and Growth: the MENA Countries 28 7. The Data The data sources we use are: • GIGA/IMES Database on political succession in the MENA region. Created by Juliane Brach at GIGA, available on request. • UCD/PRIG Armed Conflict Dataset Codebook, p. 7. • Worldbank. • The analysis focuses on the period 1980 – 2008.

  29. Political Ambiguity and Growth: the MENA Countries 29 The data we consider fall into five groups: • Growth: average growth of GDP per capita. • Strategy: industry, agriculture, fuel export. • Ambiguity: polity form (democratic to autocratic), government form, formal duration of legislature, changes of government, years in power, family ties, type of conflict the country was involved in. • Control variables: population, ln GDP. • Interaction: polity form / duration, industry / govt. form, fuel / govt. form, agriculture / govt. form.

  30. Political Ambiguity and Growth: the MENA Countries 30 8. Empirical Results Preliminary results seem to indicate that in explaining GDP per capita growth over 1980 - 2008: • of the ambiguity variables govt. form, duration and family ties are significant with the expected signs, but NOT polity form. • all the control variables type of conflict, population and ln GDP, are significant, as is the strategy variable • industry.

  31. Political Ambiguity and Growth: the MENA Countries 31 In explaining GDP per capita level of income over 1980 - 2008: • of the ambiguity variables govt. form, duration and family ties are significant and with the correct signs, but again the is no significance for the variable • polity • the control variable ln GDP, is significant, as are all the strategy variables • industry, agriculture, and fuel exports.

  32. Political Ambiguity and Growth: the MENA Countries 32 • The difference of the results in the two specification is not in line with what one would expect in standard growth regressions. • Two reasons for this come to mind: - the drivers of growth may be different from the factors that initially caused the high levels of income in the region, e.g. initial windfall profits relating to fuel extraction. - misspecification and endogeneity problems.

  33. Political Ambiguity and Growth: the MENA Countries 33 9. Concluding Remarks • Our preliminary findings seem to be in line with our initial hypothesis that ambiguity may distort policy decisions toward low growth strategies. • The result that the degree of democracy / autocracy is not significant is surprising. • The preliminary results seem to provide a good starting point for a more detailed analysis of the available data.

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