The Political Economy of Macroeconomic Policy in
Arab Resource-Rich Economies
Adeel Malik
University of Oxford
adeel.malik...
Introduction
Politics is a central dimension of macroeconomic policy: policy choices are
partly determined by political ch...
Fiscal policy – the centrality of politics
FP can be construed as an articulation of the political and social bargain
with...
KEY DECISION NODES – with political economy implication
ACCRUAL OF RESOURCE REVENUES
- How and where do resource revenues ...
COMPOSITION informs us about the nature of distributive commitments
- Distribution to citizens, elites and external patron...
Historically embedded political economy of urban provisioning
Pro-rich bias of subsidies + resistance to subsidy reform
=>...
VARIABILITY – provides us a sense of more binding political commitments
Initial fiscal bulge explained by middle class nat...
Fiscal dynamics entail an important commitment problem
How to commit rulers to prudent fiscal policy during boom years?
In...
The politics of fiscal adjustment
Mainly relevant in labour-abundant Arab RREs (e.g., Algeria)
Declining public spending =...
Pro-cyclicality of FP
Pro-cyclicality: reflects the importance of political, rather than economic,
smoothing; driven by th...
Counter-cyclical policies are partly rooted in the political objective function
- Underlying political settlement and soci...
Comparing the two oil price booms: Is there any evidence of social
learning?
Infrastructure spending is more restrained re...
Mapping the “de facto” FP regime - I
Importance of off-budget spending across the Arab RREs
Have limited knowledge of the ...
Mapping the “de facto” FP regime - II
Tight segmentation between the affairs of the Ministry of oil and the
Treasury; both...
Financial Sector – Common Pathologies
Banks are largely state-owned; limited/selective liberalization
Boundaries between t...
The politics of finance
Financial sector can be construed as providing a:
SOURCE of rents
- Rents generated through FS lib...
Beyond crude markers of financial development
Many Arab RREs have relatively deep financial structures
- one of the highes...
WHO DO BANKS LEND?
- Mainly real estate, consumer loans, housing
- Infrastructure projects
- Public sector corporations
Hi...
EXCESS LIQUIDITY
Banks tend to keep more liquidity than required by law
- Liquid assets represent 50% of total assets in Q...
COMPETITION AND TRANSPARENCY
Discretionary and fragmented decision-making means that either
connected actors at home or in...
Evidence: State-ownership of Banks
Bahrain: top 5 OBUs and top 2 IBLs own 75 percent of total sub-sector
assets.
Libya: th...
Differences in financial structure between high rent and LA RREs
STATE OWNERSHIP: more common in labour-abundant economies...
The politics of High Finance
Large financial sectors in UAE and Bahrain
- In Bahrain wholesale banks’ total assets equal 4...
Very high ratio of connected lending: Saudi banks known for large
exposure (sometimes up to 50% of bank’s own funds)
Perva...
Monetary Policy Arrangements
- Limited scope and operation of MP: most countries follow FER regimes
and permit high levels...
CHALLENGE 1: Underdeveloped debt markets
Lack well-developed markets for government securities
Imposes constraints on liqu...
POSSIBLE PE Explanation:
Political sovereign reluctant to concede space to the private sector.
Markets are generally a con...
CHALLENGE 2: Low levels of central bank independence
Most countries lack a comprehensive framework for MP
Central bank ope...
WHAT EXPLAINS the high de facto independence of Algerian Central Bank?
Emerged as a political concession in the wake of po...
The political economy of exchange rate choice
Old adage: the choice between fixed and flexible ER regimes is the choice
be...
STABILITY: Over-riding concern? Small surprises can have large political
costs.
ECONOMIC STRUCTURE:
- Dominance of the Pub...
CAPITAL MOBILITY:
Most Arab RREs are net exporters of capital
Liberalized capital accounts => drain liquidity from the sys...
Importance of linkages – General Equilibrium Effects
Hydrocarbon Dominance => implications for fiscal, financial and excha...
Concluding Remarks
Macroeconomic policies reflect the imperative of political, not economic,
stabilization
Political objec...
Absence of a clearly defined and coherent macroeconomic framework:
governments pursue macroeconomic objectives through dis...
Inherent tension between STABILITY and RESILIENCE
Impact of shocks is contained through
- Building up of reserves
- Managi...
ADDITIONAL SLIDES
High levels of de facto integration with the global economy, but low
integration with the non-oil econom...
- Discourages risk taking=> lower competitive and creative
destruction=> impedes the development of an autonomous economic...
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Political Institutions and Macroeconomic Outcomes in Arab Oil-Rich Economies - Adeel Malik

Adeel Malik, University of Oxford ERF and AFESD conference on: Monetary and Fiscal Institutions in Resource-Rich Arab Economies Kuwait, November 4-5, 2015 For more info, please visit www.erf.org.eg Opening Session While commodity volatility affects economic performance and could be associated with multiple economic ills and lack of economic development, only part of the answer lies in economics. The keynote speech will provide a political economy perspective on why some countries are able to develop resilient institutional structures, while others are not, focusing on the nature of underlying institutions in resource-rich Arab economies.
Published on: Mar 4, 2016
Published in: Government & Nonprofit      
Source: www.slideshare.net


Transcripts - Political Institutions and Macroeconomic Outcomes in Arab Oil-Rich Economies - Adeel Malik

  • 1. The Political Economy of Macroeconomic Policy in Arab Resource-Rich Economies Adeel Malik University of Oxford adeel.malik@qeh.ox.ac.uk Arab Fund for Development Kuwait November 2015 Adeel Malik PE of Macroeconomic Policy - 1
  • 2. Introduction Politics is a central dimension of macroeconomic policy: policy choices are partly determined by political choices This presentation assumes knowledge of the global literature and basic MENA patterns Focus on fiscal and financial policies, and linkages between different aspects of macro policy Shock-prone, but resilience depends on deep pockets rather than sound institutions Adeel Malik PE of Macroeconomic Policy - 2
  • 3. Fiscal policy – the centrality of politics FP can be construed as an articulation of the political and social bargain with the population – or the nature of underlying political settlement Acts as a prime means of rent distribution to citizens and elites Patronage commitments to purchase consent (downwardly sticky but evolving upward adjustment) => manifested through pro-cyclicality FP mostly about spending, not taxes; in state capacity terms, Arab RREs are not extractive states Reflection of state autonomy (esp. with a weak tax effort) – but this autonomy is variable over time Adeel Malik PE of Macroeconomic Policy - 3
  • 4. KEY DECISION NODES – with political economy implication ACCRUAL OF RESOURCE REVENUES - How and where do resource revenues accrue? - Are they transparently published and recorded - Important for determining the extra-fiscal space SPENDING How much to spend? What determines the composition and variability of spending? How much to save and how? TIME INCONSISTENCY Focus on structural misalignment of incentives Optimal political responses in periods of low oil prices may not be the same as those in boom periods Adeel Malik PE of Macroeconomic Policy - 4
  • 5. COMPOSITION informs us about the nature of distributive commitments - Distribution to citizens, elites and external patrons - Resources for repression and distribution RREs typically spend substantial sums on social services and other patronage commitments: crucial for understanding the politics of the middle class - salaries and subsidies - Health, education, social services - Housing loans In GCC states between 40-60% of government budgets are consumed by wages and social service provision Adeel Malik PE of Macroeconomic Policy - 5
  • 6. Historically embedded political economy of urban provisioning Pro-rich bias of subsidies + resistance to subsidy reform => rooted in a dependent middle class constituency, role of rent-seeking intermediaries, etc. INFRASTRUCTURE: Driven by the politics of development and rent distribution to elites; Debate largely centres around “white elephant projects” with low-returns; Determinants of project selection? How important is connected capital? Adeel Malik PE of Macroeconomic Policy - 6
  • 7. VARIABILITY – provides us a sense of more binding political commitments Initial fiscal bulge explained by middle class nationalism, early investments in human development, etc. In times of adjustment, some expenditure commitments are more binding than others: - Civil-service wages and subsidies more resilient in RREs - Health and education spending is similarly resilient - Robust spending on “coercive apparatus” even during downturns - Investment spending sharply curtailed during busts Adeel Malik PE of Macroeconomic Policy - 7
  • 8. Fiscal dynamics entail an important commitment problem How to commit rulers to prudent fiscal policy during boom years? In non-Arab RREs where political turnover is generally higher the issue is largely about inconsistent fiscal incentives of different political govts. Given the greater regime durability in Arab RREs long-run fiscal sustainability is more important issue Despite growing concerns about fiscal sustainability there are limited political incentives for any individual ruler to contain spending LOGIC: even if the prevailing fiscal regimes re unsustainable over the long- run they are sustainable over the lifespan of the individual ruler Adeel Malik PE of Macroeconomic Policy - 8
  • 9. The politics of fiscal adjustment Mainly relevant in labour-abundant Arab RREs (e.g., Algeria) Declining public spending => erosion of the social contract => Middle class grievance Burden of fiscal adjustment fell disproportionately on middle classes and the poor. Essential for understanding the age of protest politics The ability of Arab RREs to ride through the political crisis is based on oil resources, not good institutions Ability of withstand shocks rests almost completely on the available resource envelope Adeel Malik PE of Macroeconomic Policy - 9
  • 10. Pro-cyclicality of FP Pro-cyclicality: reflects the importance of political, rather than economic, smoothing; driven by the imperative of regime stability - Subsidies and salaries => rise disproportionately with rising oil prices, but show downward stickiness - FP also drives cycles in public and private investment - Growing expenditure commitments during good times => depleting fiscal buffers => limited ability to absorb shocks Adeel Malik PE of Macroeconomic Policy - 10
  • 11. Counter-cyclical policies are partly rooted in the political objective function - Underlying political settlement and social contract - Few constituencies with countervailing powers - Strength of the “Sovereign” relative to productive sectors of the economy/autonomy Weak role of automatic fiscal stabilizers => Asymmetric adjustment of expenditures and revenues Expenditures respond more quickly to oil price cycles than revenues Adeel Malik PE of Macroeconomic Policy - 11
  • 12. Comparing the two oil price booms: Is there any evidence of social learning? Infrastructure spending is more restrained relative to the first oil boom Evidence of higher savings in good times than before – extensive reliance on stabilization Funds (size in GCC: approx. $1.8 trillion) - Continuing issues of transparency; operations of SWFs are usually opaque; - Withdrawal rules are usually neither well-spelled out nor adequately implemented; - Debate over form versus substance - Overseas investments of SWFs: part of investment/diversification strategy or “external commitments”? Adeel Malik PE of Macroeconomic Policy - 12
  • 13. Mapping the “de facto” FP regime - I Importance of off-budget spending across the Arab RREs Have limited knowledge of the functioning of budgetary institutions Quasi public spending through public sector enterprises also relatively unexplored Large components of spending evade fiscal accounting Examples abound: land sales, tax benefits, oil and budgetary support for neighbours, military spending, military purchases, etc. Contingent liabilities in the geo-political domain Adeel Malik PE of Macroeconomic Policy - 13
  • 14. Mapping the “de facto” FP regime - II Tight segmentation between the affairs of the Ministry of oil and the Treasury; both are governed by different decision logics - Finances of state petroleum companies not disclosed - Is there high level of resource fungibility in the former? - What is the number and strength of veto players in the system? Additional complication: limited distinction between whether oil is a public or private wealth Fundamental Q: Where does the authority for fiscal decisions rest? Who are the veto players? Adeel Malik PE of Macroeconomic Policy - 14
  • 15. Financial Sector – Common Pathologies Banks are largely state-owned; limited/selective liberalization Boundaries between the public and the private are blurred (high concentration of banking sector assets) Credit allocation and financial intermediation are often politically controlled (whether through explicit or implicit means); Domestic debt market remains under-developed; High reserve requirements: volatility avoidance is the dominant concern; Weak regulatory framework Adeel Malik PE of Macroeconomic Policy - 15
  • 16. The politics of finance Financial sector can be construed as providing a: SOURCE of rents - Rents generated through FS liberalization (control of licenses); - financing oligarchic interests masquerading as the public sector MECHANISM for rent distribution - Subsidized loans for consumers (esp. Housing-related) - Targeted sectors: SME, agriculture, other preferential sectors Financial Sector usually - acts as the principal intermediary between the state and the rest of the economy; - serves more a distributive rather than a productive function Adeel Malik PE of Macroeconomic Policy - 16
  • 17. Beyond crude markers of financial development Many Arab RREs have relatively deep financial structures - one of the highest deposits to GDP ratios - extends reasonably high levels of credit - high levels of financial openness (except for Iraq, Algeria and Yemen). HOWEVER: financial depth does not translate into financial access - Large deposit base of banks but limited credit to the private sector - One of the most concentrated loan portfolios in the world (Ratio of the top 20 exposures to total liquidity is 182% in GCC) - Large exposures to a handful of borrowers Adeel Malik PE of Macroeconomic Policy - 17
  • 18. WHO DO BANKS LEND? - Mainly real estate, consumer loans, housing - Infrastructure projects - Public sector corporations High exposure to real-estate lending (In Bahrain Islamic Banks are especially exposed) Kuwait: real estate market represents about 18.5% of total investment and over 60% of total collateral Saudi Arabia: Real estate credit has grown by 30% from a small base UAE: real estate represents a significant portion of banks’ credit portfolio Controlled forms of capital accumulation (land is in the hands of government or connected actors Adeel Malik PE of Macroeconomic Policy - 18
  • 19. EXCESS LIQUIDITY Banks tend to keep more liquidity than required by law - Liquid assets represent 50% of total assets in Qatar - High reserve requirements can be a tax on financial intermediation - One of the lowest bank credit to deposits ratio Earnings from hydrocarbons => determines Banks’ funding base (not through the “endogenous dynamics of depositing institutions”) Exogenous resource flows > intermediation capacity of the FS - Volatility of hydrocarbon revenues - Fewer lending opportunities in the non-oil sector - Institutional impediments: credit information, collateral registries, bank resolution, legal rights of creditors Adeel Malik PE of Macroeconomic Policy - 19
  • 20. COMPETITION AND TRANSPARENCY Discretionary and fragmented decision-making means that either connected actors at home or influential foreign parties are given licenses for banks Limited disclosure of investment policies, portfolio and performance of PSEs and core public financial institutions In Algeria: the government is the largest bank owner, it acts as a regulator and it is the main client (through the SOEs). Weak crisis management: the standard response is government recapitalization of banks, deleveraging or complete liquidation Adeel Malik PE of Macroeconomic Policy - 20
  • 21. Evidence: State-ownership of Banks Bahrain: top 5 OBUs and top 2 IBLs own 75 percent of total sub-sector assets. Libya: the government owns 5 of the 15 commercial banks, representing 60 percent of total assets Oman: “Government and quasi-government institutions own more than 26 percent of the assets of the banking system” (Bologna and Prasad 2013); Also, three largest banks accounted for 65% of total assets! Saudi Arabia: 12 Saudi incorporated banks control 95% of total bank assets, the 7 largest banks control 85% of assets, 3 largest 45%, all of which are government entities (Very similar pattern in Algeria and Qatar) Adeel Malik PE of Macroeconomic Policy - 21
  • 22. Differences in financial structure between high rent and LA RREs STATE OWNERSHIP: more common in labour-abundant economies with a socialist legacy of state intervention - With more extensive distributional commitments, labour-abundant RREs use the banking sector to distribute rents to favoured constituents; - High share of non-performing loans - Greater informalization of the financial sector - Mild forms of financial repression (with some explicit or implicit capping of interest rates) Adeel Malik PE of Macroeconomic Policy - 22
  • 23. The politics of High Finance Large financial sectors in UAE and Bahrain - In Bahrain wholesale banks’ total assets equal 480% of GDP, retail bank assets equal 270% of GDP - Financial sector serves as a politically safe avenue for diversification - The bulk of lending is geared towards connected parties and real estate Overlapping structures of ownership and control (shareholders): state entities are sometimes the dominant shareholders of largest banks Kuwait: government-owned banks => significant stakes in investment companies => which, in turn, have stakes in commercial and industrial groups. Adeel Malik PE of Macroeconomic Policy - 23
  • 24. Very high ratio of connected lending: Saudi banks known for large exposure (sometimes up to 50% of bank’s own funds) Pervasive role of “related parties in bank lending” Adeel Malik PE of Macroeconomic Policy - 24
  • 25. Monetary Policy Arrangements - Limited scope and operation of MP: most countries follow FER regimes and permit high levels of capital mobility - MP is largely about liquidity management through greater reliance on indirect MP tools, such as Reserve Requirements and Repurchasing Agreements. - Government deposits are an important component of overall liabilities of central bank balance sheets - The interest rate channel of MP plays a relatively insignificant role: low sensitivity to policy interest rates. - MP is effectively insulated from fiscal pressures (monetization of fiscal deficits is rare) - The main concern is to restrain the impact of external shocks Adeel Malik PE of Macroeconomic Policy - 25
  • 26. CHALLENGE 1: Underdeveloped debt markets Lack well-developed markets for government securities Imposes constraints on liquidity management and reduces the effectiveness of open market operations Difficulty of building a benchmark yield curve => reduces the effectiveness of MP instruments More than 50% of sukuk issuance is based in the UAE (even here it is difficult to build a critical mass of sukuks) => undiversified investor base Captive demand by the banking sector and PSEs => highly concentrated buy and hold portfolio Lack of competition from institutional investors who are protected by government through regulatory, accounting and tax arbitrage Adeel Malik PE of Macroeconomic Policy - 26
  • 27. POSSIBLE PE Explanation: Political sovereign reluctant to concede space to the private sector. Markets are generally a controlled domain => primed to produce concentration and fragmentation Independent market linkages could foster competition and empower the private sector (remains a difficult power proposition Majority of trades take place between central banks and banks: inter-bank markets are either limited or inactive Adeel Malik PE of Macroeconomic Policy - 27
  • 28. CHALLENGE 2: Low levels of central bank independence Most countries lack a comprehensive framework for MP Central bank operations subordinated to the demands of the external sector Political independence of central banks is limited – subject to overriding instructions from central authorities Absence of clearly stated rules and objectives that could act as “commitment devices” (quantifiable objectives, targets, instruments, etc) Largely a reflection of unpredictable and discretionary policy regime Absence of an “independent” constituency that could demand and receive policy signals => key macro variables, such as output, inflation and employment, thus remain outside the purview of MP Adeel Malik PE of Macroeconomic Policy - 28
  • 29. WHAT EXPLAINS the high de facto independence of Algerian Central Bank? Emerged as a political concession in the wake of potent economic pressures and violence in the 1980s Algeria was obliged to seek external donor support and sign up on the IMF’s Structural Adjustment Programme LESSON: Where instability and unemployment are higher and foreign exchange reserves are more precarious => more likely to have relatively independent central bank independence and flexible ER arrangements Adeel Malik PE of Macroeconomic Policy - 29
  • 30. The political economy of exchange rate choice Old adage: the choice between fixed and flexible ER regimes is the choice between good and bad macroeconomic policy The structural economic and political factors traditionally emphasized by the literature do not predict the de facto ER regimes in MENA SUSTAINABILITY: countries with high reserves to import ratios are more likely to adopt Fixed ER regimes Hydrocarbon wealth tends to shield Arab RREs from underlying economic compulsions that determine common choices around MP and ER regimes CREDIBILITY: Question of credibility (politically cheap instrument – harder to build credibility through good policies, which require a predictable and non-discretionary arrangement) Adeel Malik PE of Macroeconomic Policy - 30
  • 31. STABILITY: Over-riding concern? Small surprises can have large political costs. ECONOMIC STRUCTURE: - Dominance of the Public sector - Relative insignificance of the export sector => absence of an independent economic constituency that might wish to see its interests articulated through Monetary and ER policies. - High degree of import dependence => the fate of merchant classes is closely tied with import agencies and licensed distribution of products PRICE STABILITY: High dependence on food and consumer imports (Although inflationary pressures from food imports are typically controlled through subsidies). Adeel Malik PE of Macroeconomic Policy - 31
  • 32. CAPITAL MOBILITY: Most Arab RREs are net exporters of capital Liberalized capital accounts => drain liquidity from the system and prevent Dutch Disease effects; limited domestic absorptive capacity BUT there is a COMPLIMENTARY political logic of capital mobility: - External recycling of rents to buy geo-strategic leverage (not always governed by purely economic rates of return); - Trillions of dollars invested in buying companies, US Treasury bills, charity contributions, infrastructure projects, etc.; - Arms purchases, fiscal support for neighbouring governments, financing for external interventions Such external flows can act as BINDING POLITICAL COMMITMENTS for regime stability. Adeel Malik PE of Macroeconomic Policy - 32
  • 33. Importance of linkages – General Equilibrium Effects Hydrocarbon Dominance => implications for fiscal, financial and exchange rate policies State-ownership of banks => under-developed debt markets => fewer instruments available to manage liquidity and shocks - Limited development or non-existence of secondary markets for government securities => hinders the broad use of open market operations by central banks Excess liquidity => inflation is controlled largely through high deposit ratios and reserve requirements => lower private sector credit Algeria: Exchange rate controls => implications for FS and MP Adeel Malik PE of Macroeconomic Policy - 33
  • 34. Concluding Remarks Macroeconomic policies reflect the imperative of political, not economic, stabilization Political objective function is the key to understanding macro outcomes With a FER regime and the primacy of the external sector, fiscal and financial policies are more important from a political economy standpoint With limited scope of MP, the commitment problem is more pressing in the fiscal domain: institutionalized constraints on the fiscal regime are more important than central bank independence Quasi-public sector activities and de factor FP regime are largely unmapped Adeel Malik PE of Macroeconomic Policy - 34
  • 35. Absence of a clearly defined and coherent macroeconomic framework: governments pursue macroeconomic objectives through discretionary and fragmented policies. Absence of an independent economic constituency that could demand and receive policy signals No institutionalized framework for macroeconomic policy that is shaped by lobbying, bargaining and feedback from the private sector Adeel Malik PE of Macroeconomic Policy - 35
  • 36. Inherent tension between STABILITY and RESILIENCE Impact of shocks is contained through - Building up of reserves - Managing the degree of exposure to global markets - Reliance on centralized control rather than market-based instruments In other words: stability is achieved largely by adjusting the distributional equilibrium rather than building institutional resilience Adeel Malik PE of Macroeconomic Policy - 36
  • 37. ADDITIONAL SLIDES High levels of de facto integration with the global economy, but low integration with the non-oil economy Two equilibriums: high exposure to external shocks in one set of countries (UAE, Bahrain), limited in another (RREs) In both cases, financial stability does not rest on strong institutions (stability rests largely on degree of market integration) Effects of external shocks are usually contained through limited exposure to international financial system) Domestic debt markets under-developed through-out the region Policy environment is both economically and politically conservative Adeel Malik PE of Macroeconomic Policy - 37
  • 38. - Discourages risk taking=> lower competitive and creative destruction=> impedes the development of an autonomous economic constituency Adeel Malik PE of Macroeconomic Policy - 38

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