Newly released competitiveness rankings place the US first. This year’s rankings are different than those from years prior, because they place greater emphasis on institutional factors, and less on green-eyeshade fiscal/macroeconomic factors:
However, the U.S.’s sharp climb was due to a change in methodology that gives more weight to market-related factors in the survey, relative to macroeconomic criteria on which the U.S. is weak. Under the new methodology, the U.S. would have topped the rankings last year, too.
“The U.S. does amazingly well on innovation and markets, but on the macroeconomic-stability pillar it ranks 75th” out of 131 countries included in the survey, said Jennifer Blanke, the forum’s chief economist and a co-author of the report. “This still reflects a very serious problem that could hurt the U.S. in the future.”
The U.S. scores badly for high levels of government debt and deficits and a low savings rate that reflects overextension among U.S. households. The recent credit crunch, triggered by problems in the subprime-mortgage market, is an example of the risks these weaknesses hold for the U.S. and global economies, according to the survey’s authors.
This greater emphasis on institutional factors–“market factors” in the lingo of the report–is entirely warranted, but based on descriptions of the methodology in the press, I have my doubts about the overall reliability of the methodology, and the conclusions based thereon. Specifically:
Among surprising performers are countries from the Middle East and Central Asia, many rich in oil and natural gas and several new to the survey this year. Kuwait, Qatar and Tunisia ranked 30th to 32nd, respectively, beating all but one of the dozen countries that recently joined the European Union, as well as China and India.
Saudi Arabia, the United Arab Emirates, Oman and Bahrain followed close behind. They also beat several EU countries, including Italy, Hungary and Poland. Russia, at 58th, and Uzbekistan, a natural-gas-producing dictatorship in Central Asia, rank ahead of EU laggards Greece, Romania and Bulgaria.
Those rankings reflect a revenue windfall from high energy prices that has given these countries strong macroeconomic stability. It has also provided the means to fix basic productivity drags on their economies, such as poor education, rampant unemployment and minimal female work-force participation, Ms. Blanke noted.
“Right now they have so much potential,” Ms. Blanke said. “The question is what they do with it.” If they don’t use the windfall wisely, then a sharp drop in commodity prices could see their competitiveness drop quickly, she added. [Emphasis mine.]
“If they don’t use the windfall wisely” indeed. Err, ever heard of the “resource curse,” Ms. Blanke? It is well documented that countries with resource windfalls–particularly, dramatic improvements in their terms of trade attributable to spikes in prices of primary commodities they produce–tend to perform very badly economically. There are many competing hypotheses regarding the channels through which the curse manifests itself. The earliest hypothesis is the “Dutch Disease” channel, whereby the resource boom causes an appreciation in the commodity producer’s currency, placing its tradeables sector (primarily manufacturing) at a competitive disadvantage, leading to a flow of resources into non-tradeables production. If there are positive spillovers (e.g., learning by doing) in the tradeables sector, but not in the non-tradeables sector, this can lead to poor future growth performance.
Other theories focus on the political economy effects of resource booms. I consider these theories much more plausible, and they speak directly to the wisdom of public expenditures in countries reaping a resource windfall, and the chimerical nature of “macroeconomic stability” in these nations. The basic idea behind these theories is that the commodity price boom leads to a diversion of resources into non-productive uses primarily because the windfall is distributed by politicians according to political, rather than efficiency, criteria.
These types of theory also come in many flavors, but the Robinson-Torvik-Verdier article published in the Journal of Development Economics in 2006 is a good example with some interesting implications of direct relevance to the competitiveness analysis. In their model, politicians use the windfall to direct goodies to their political supporters. Because politicians’ promises of delivering checks to supporters in the future are not credible, efficient transfers are not possible. Instead, politicians must buy votes with inefficient mechanisms–such as increased public employment–that are credible. (Read the paper to see why public employment is a credible way to shower benefits on supporters.) [NB. This is actually a variant on Stigler’s old theory of why politicians/regulators use inefficient mechanisms like entry barriers rather than distribution of cash.] Thus, in the Robinson et al model, political considerations lead to the direction of the commodity boom windfall to unproductive sectors of the economy, dampening future economic growth.
This model, and other political economy resource boom models, predict that “spending the windfall wisely” is the exception rather than the rule, and both cross country and case study evidence is strongly supportive of this view. Thus, the “potential” of resource boom countries is likely a mirage, and “macroeconomic stability” too often disappears in a splurge of wasteful public spending.
The Robinson et al article also predicts that the effects of a resource boom depend on the institutional framework of the country receiving the windfall. Countries with weak political institutions–those that do not “promote accountability and state competence”–will tend to suffer from resource booms, while those with strong institutions will benefit. (A paper by Durnev and Guriev provides another model of a different mechanism by which institutional quality affects the severity of the resource curse.) Thus, the countries named in the competitive rankings as potential beneficiaries of the commodity price boom–Saudi Arabia, the United Arab Emirates, Oman, Bahrain, Russia, and Uzbekistan–are in fact unlikely to thrive despite high oil prices because each is plagued by weak institutions.
As an interesting contrast, historically Australia, Canada, and the US had natural resource intensive economies, but did not suffer from resource curses. The most reasonable explanation; these nations inherited a strong legal and property rights framework from Britain that antedated the development of natural resources. Moreover, these resources were largely privately owned.
Indeed, the resource booms can actually corrode already weak institutions even further. In this regard, an article by former Russian Deputy Energy Minister Vladimir Milov is particularly illuminating in this regard:
After several years, the phrases related to the creation of the rule of law and the dictatorship of law have disappeared from the official lexicon. The YUKOS case has become the apotheosis of the destruction and discrediting of the Russian legal system. The case has launched the odious “tax terror”, (which, in practice, is based on a replacement of the presumption of a lawful conduct of a taxpayer with the presumption of guilt). The case also showed full dependency of the courts on the executive. As soon as YUKOS assets passed from one owner to the other, the courts at once reconsidered their previous decisions on “tax debts”. . . .
A special law limiting access of foreign investors to strategic areas of economy has still not been adopted. Despite this fact, the authorities have been limiting the foreign access at will. They simply do not need the law, since in reality informal mechanisms determine everything.
The natural resource sector–and the oil and gas sector in particular–has been the primary target of the assault on the rule of law and the security of property rights within Russia, but Mirov suggests that the damage resulting from this assault is not limited to this sector alone, but instead has undermined property rights and the rule of law in Russia generally. This is not conducive to good future economic performance, and indeed, will likely cripple future growth prospects.
So, despite the salutary changes in the computation of the competitiveness rankings, the compilers of the rankings are missing a major part of the competitiveness picture. By viewing the resource boom primarily through the filter of government budgetary considerations, and failing to recognize that resource booms can undermine the very institutions that they rightly acknowledge are major contributors to economic growth, they exaggerate the potential of the resource boom countries. ” If they spend the windfall wisely they will do well.” This is a conditional statement, and the condition under which it holds is highly unlikely to be true. My uncle liked to quote a Chief Petty Officer who was wont to say: “If . Yeah, if frogs had wings they wouldn’t bump along on their butts.” The authors of the competitiveness rankings imagine that resource boom countries have wings to fly, but in reality, they are likely to bump along frog-like because of the deleterious effects of commodity price booms on the allocation of resources in countries with weak institutions.
